Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving Proposed Rule Change, as Modified by Amendment No. 1, To Adopt Existing NASD IM-2110-3 as New FINRA Rule 5270 (Front Running of Block Transactions) With Changes in the Consolidated FINRA Rulebook, 55519-55523 [2012-22139]
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Federal Register / Vol. 77, No. 175 / Monday, September 10, 2012 / Notices
execution to another broker that uses a
different trigger for stop orders, and
executions of quotation-triggered stop
orders at prices at which the stock had
not traded that day.39 FINRA also had
considered retaining the existing rule to
require that only transactions trigger
stop orders and stop limit orders.40
However, certain FINRA members were
concerned that trades outside the
current market, whether permissible
transactions or clearly erroneous trades,
could improperly trigger transactionbased stop orders and stop limit orders,
and believed that quotations may serve
as a better indicator of current market
price for thinly traded securities.41
FINRA believes the proposed
approach—to retain the default trigger
while permitting the use of other
triggers and requiring disclosure of
those triggers—strikes the appropriate
balance in addressing the views
expressed by FINRA members.42 In
particular, FINRA believes that the
proposal would provide members with
flexibility in offering various order
types, while also addressing concerns
regarding the potential for investor
confusion with respect to the operation
of stop orders.43
FINRA states that the purpose of the
proposed rule change is to make explicit
in FINRA rules that firms are permitted
to offer stop orders and stop limit orders
that are triggered by an event other than
a transaction, such as a quotation, as
long as that order type is clearly
differentiated from stop orders and stop
limit orders triggered by a transaction.44
Contrary to views expressed by
commenters, FINRA does not believe
the proposed rule change would impose
additional costs on members that offer
stop orders and stop limit orders given
the current requirement to use a
transaction-based trigger for orders
labeled as ‘‘stop’’ or ‘‘stop limit,’’ thus
requiring order types that use an
alternative trigger to be labeled
differently.45 In addition, FINRA is
concerned that allowing the trigger for
stop orders and stop limit orders to vary
solely based on customer consent may
diminish the level of certainty for
customers as to how stop orders would
be treated and would result in less
uniformity in the handling of stop
orders and stop limit orders.46
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39 See
id.
40 See id. at 4.
41 See id. at 3.
42 See id. at 4.
43 See id.
44 See id. at 2.
45 See id. at 4.
46 See id. Finally, FINRA notes that it will
provide an implementation period of no less than
90 days following Commission approval of the
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IV. Discussion and Commission’s
Findings
After careful review of the proposed
rule change, the comment letters
received, and FINRA’s response, the
Commission finds that the proposed
rule change is consistent with the
requirements of Section 15A(b) of the
Act 47 and the rules and regulations
thereunder applicable to a national
securities association.48 In particular,
the Commission finds that the proposed
rule change is consistent with Section
15A(b)(6) of the Act,49 which requires,
among other things, that FINRA rules be
designed to prevent fraudulent and
manipulative acts and practices, to
promote just and equitable principles of
trade, and, in general, to protect
investors and the public interest.
FINRA’s proposal would allow the
use of transaction-based stop orders and
stop limit orders by providing a uniform
definition of ‘‘stop order’’ and ‘‘stop
limit order’’ while also allowing
member firms to offer order types that
are triggered by an event other than a
transaction (e.g., a quotation).50 The
Commission notes that a member that
provides an order type that is triggered
by an event other than a transaction at
the stop price cannot label the order
type a ‘‘stop order’’ or a ‘‘stop limit
order,’’ and must clearly distinguish the
order type from a ‘‘stop order’’ and a
‘‘stop limit order.’’ 51 In addition, the
member must disclose to the customer,
in paper or electronic form, prior to the
time the customer places the order, a
description of the order type including
the triggering event.52
While several commenters advocated
for an alternative approach and raised
concerns regarding a potential burden as
a result of the proposal, the Commission
believes that FINRA’s proposal would
allow members flexibility in the types of
orders they offer and provide for
disclosure to customers regarding the
operation of such orders. In this regard,
the Commission notes that FINRA
weighed various alternatives and took
into account extensive input from its
members in formulating the proposal.53
proposed rule change to provide members that
determine to offer stop orders and stop limit orders
with alternative triggers with time to make
necessary technology changes. See id.
47 15 U.S.C. 78o–3(b).
48 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).
49 15 U.S.C. 78o–3(b)(6).
50 See Proposed FINRA Rule 5350.
51 See Proposed FINRA Rule 5350,
Supplementary Material .01.
52 See id.
53 See Notice, supra note 3, at 33537; and FINRA
Response at 2.
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55519
In addition, the Commission notes
FINRA’s belief that the proposal should
not impose additional costs on firms
that continue existing practices
consistent with FINRA rules.54 Further,
the Commission notes FINRA’s concern
that permitting stop order triggers to
vary solely based on customer consent,
as suggested by commenters, could
undermine the ability of customers to
understand how their stop orders would
be handled.55
The Commission believes that
FINRA’s proposal sufficiently addresses
issues regarding FINRA’s previous
proposed rule change, which would
have deleted in its entirety the
provisions of FINRA Rule 6140 relating
to the handling of stop orders by
member firms.56 The Commission
believes that FINRA’s proposal should
enhance the ability of investors to
understand the key attributes of order
types offered by their brokers so that
they can make informed choices as to
whether to use a particular type of
order.
V. Conclusion
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,57 that the
proposed rule change (SR–FINRA–
2012–026) is approved.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.58
Kevin M. O’Neill,
Deputy Secretary.
[FR Doc. 2012–22142 Filed 9–7–12; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–67774; File No. SR–FINRA–
2012–025]
Self-Regulatory Organizations;
Financial Industry Regulatory
Authority, Inc.; Order Approving
Proposed Rule Change, as Modified by
Amendment No. 1, To Adopt Existing
NASD IM–2110–3 as New FINRA Rule
5270 (Front Running of Block
Transactions) With Changes in the
Consolidated FINRA Rulebook
September 4, 2012.
I. Introduction
On May 17, 2012, Financial Industry
Regulatory Authority, Inc. (‘‘FINRA’’) (f/
54 See
FINRA Response at 4.
id.
56 See Securities Exchange Act Release No. 63885
(February 10, 2011), 76 FR 9062 (February 16, 2011)
(Order Disapproving SR–FINRA–2010–055).
57 15 U.S.C. 78s(b)(2).
58 17 CFR 200.30–3(a)(12).
55 See
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Federal Register / Vol. 77, No. 175 / Monday, September 10, 2012 / Notices
k/a National Association of Securities
Dealers, Inc. (‘‘NASD’’)) filed with the
Securities and Exchange Commission
(‘‘Commission’’), pursuant to Section
19(b)(1) of the Securities Exchange Act
of 1934 (‘‘Act’’) 1 and Rule 19b–4
thereunder,2 a proposed rule change to
adopt existing NASD Interpretive
Material (‘‘IM’’) 2110–3 (Front Running
Policy) as proposed FINRA Rule 5270 to
amend the existing Front Running
Policy in several ways to broaden its
scope and provide further clarity into
activities that FINRA believes are
inconsistent with just and equitable
principles of trade. The proposed rule
change was published for comment in
the Federal Register on June 6, 2012.3
The Commission received two comment
letters on the proposed rule change,4
and a response to comments from
FINRA.5 On August 30, 2012, FINRA
submitted Amendment No. 1 to the
proposal.6 This order approves the
proposed rule change, as modified by
Amendment No. 1.
II. Description of the Proposal
As part of the process of developing
a consolidated rulebook,7 FINRA
proposed to adopt existing NASD IM–
2110–3 (‘‘Front Running Policy’’) as
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 See Securities Exchange Act Release No. 67079
(May 30, 2012), 77 FR 33522 (‘‘Notice’’).
4 See Letters to Elizabeth M. Murphy, Secretary,
Commission, from Ryan K. Bakhtiari, President,
Public Investors Arbitration Bar Association
(‘‘PIABA’’), dated June 26, 2012 (‘‘PIABA Letter’’);
and Sean Davy, Managing Director, Corporate
Credit Markets Division, Securities Industry and
Financial Markets Association (‘‘SIFMA’’), dated
July 9, 2012 (‘‘SIFMA Letter’’).
5 See Letter from Brant K. Brown, Associate
General Counsel, FINRA, to Elizabeth M. Murphy,
Secretary, Commission, dated August 29, 2012
(‘‘FINRA Response’’).
6 In that amendment, FINRA clarified that the
proposed rule would not apply to orders or
transactions involving government securities.
FINRA noted, however, that actions for similar
front-running conduct occurring in the exempted
securities markets, including the government
securities market, continue to be covered by FINRA
Rule 2010. In the amendment, FINRA also clarified
that the 10,000 share language in proposed
Supplementary Material .03 refers to equity
securities. Because this amendment is technical in
nature, it is not subject to notice and comment.
7 The FINRA rulebook consists of: (1) FINRA
Rules; (2) NASD Rules; and (3) rules incorporated
from NYSE (‘‘Incorporated NYSE Rules’’) (together,
the NASD Rules and Incorporated NYSE Rules are
referred to as the ‘‘Transitional Rulebook’’). While
the NASD Rules generally apply to all FINRA
members, the Incorporated NYSE Rules apply only
to those members of FINRA that are also members
of the NYSE (‘‘Dual Members’’). The FINRA Rules
apply to all FINRA members, unless such rules
have a more limited application by their terms. See
FINRA Information Notice, March 12, 2008
(Rulebook Consolidation Process).
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2 17
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proposed FINRA Rule 5270 with the
changes described below.
A. Current Front Running Policy
The current Front Running Policy
states that it shall be considered
conduct inconsistent with just and
equitable principles of trade for a
member or a person associated with a
member, for an account in which such
member or person associated with a
member has an interest or exercises
investment discretion or for certain
customer accounts, to buy or sell an
option or security future when the
member or person associated with a
member has material, non-public market
information concerning an imminent
block transaction 8 in the underlying
security or when the customer has been
provided such material, non-public
market information by the member of
any person associated with a member.9
Similarly, the same prohibition applies
for a member or any person associated
with a member with respect to an order
to buy or sell an underlying security
when such member or person associated
with a member causing such order to be
executed has material, non-public
market information concerning an
imminent block transaction in an option
or a security future overlying that
security, or when a customer has been
provided such material, non-public
market information by the member or
any person associated with a member;
prior to the time information concerning
the block transaction has been made
publicly available.10
The Front Running Policy also
prohibits providing material, non-public
market information concerning an
imminent block transaction to
customers who then trade on the basis
of the information. The Front Running
Policy is limited to transactions in
equity securities and options that are
required to be reported on a last sale
reporting system and to any transaction
involving a security future, regardless of
whether the transaction is reported. The
prohibitions apply until the information
concerning the block transaction has
been made publicly available.11
8 NASD IM–2110–3 states that ‘‘[a] transaction
involving 10,000 shares or more of an underlying
security, or options or security futures covering
such number of shares is generally deemed to be a
block transaction, although a transaction of less
than 10,000 shares could be considered a block
transaction in appropriate cases.’’
9 See NASD IM–2110–3(a).
10 See NASD IM–2110–3(b).
11 See NASD IM–2110–3 (‘‘when [the
information] has been disseminated via the tape or
high speed communications line of one of those
systems, a similar system of a national securities
exchange under Section 6 of the Act, an alternative
trading system under Regulation ATS, or by a thirdparty news wire service’’).
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Finally, the Front Running Policy
includes exceptions for ‘‘transactions
executed by member participants in
automatic execution systems in those
instances where participants must
accept automatic executions’’ as well as
situations where a member receives a
customer’s block order relating to both
an option or security future and the
underlying security and the member, in
furtherance of facilitating the customer’s
block order, positions the other side of
one or both components of the order. In
the latter case, a member is still
prohibited from covering any resulting
proprietary position by entering an
offsetting order until information
concerning the block transaction has
been made publicly available.
B. Proposed Changes to Front Running
Policy
1. Expansion of the Front Running
Policy
FINRA proposes to expand the Front
Running Policy to apply to all securities
and other financial instruments and
contracts (in addition to the existing
options and security futures) that
overlay the security that is the subject
of an imminent block transaction and
that have a value that is materially
related to, or otherwise acts as a
substitute for, the underlying security.
Specifically, FINRA proposes to expand
the Front Running Policy to cover
trading in an option, derivative,
security-based swap, or other financial
instrument overlying a security that is
the subject of an imminent block
transaction if the value of the
underlying security is materially related
to, or otherwise acts as a substitute for,
such security, as well as any contract
that is the functional economic
equivalent of a position in such security
(‘‘related financial instrument’’).12
The proposal would also expand the
Front Running Policy when the
imminent block transaction involves a
related financial instrument, and
prevent trading in the underlying
security. The proposed rule change also
would extend the Front Running Policy
to include explicitly trading in the same
security or related financial instrument
that is the subject of an imminent block
transaction.13
12 FINRA notes that the proposed rule is not
intended to provide an exhaustive list of prohibited
trading activity. See Notice, supra note 3.
13 The trading restrictions imposed by the current
Front Running Policy apply until information about
the imminent customer block transaction ‘‘has been
made publicly available,’’ which the rule defines as
having been disseminated to the public in trade
reporting data. The proposed rule change generally
retains this standard for determining when
information has become publicly available.
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2. Amended Exceptions to the Front
Running Policy
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The proposed rule change would
replace several existing provisions in
the Front Running Policy with proposed
Supplementary Material to FINRA Rule
5270. FINRA proposes to replace the
existing exceptions in the Front
Running Policy for certain transactions
in automatic execution systems and for
positioning the other side of certain
orders when a member receives a
customer’s block order relating to both
an option and the underlying security or
both a security future and the
underlying security. The new
Supplementary Material identifies types
of transactions that are permitted.
Specifically, under the proposed
Supplementary Material, there would be
three broad categories of permitted
transactions: (1) Transactions that the
member can demonstrate are unrelated
to the customer block order; (2)
transactions that are undertaken to
fulfill or facilitate the execution of the
customer block order; or (3) transactions
that are executed, in whole or in part,
on a national securities exchange and
comply with the marketplace rules of
that exchange. These three categories of
permitted transactions are discussed
below.
First, with respect to transactions that
are unrelated to the customer block
order, Supplementary Material .04(a)
would allow members to engage in such
transactions provided that the member
can demonstrate that the transactions
are unrelated to the material, non-public
market information received in
connection with the customer order.
The Supplementary Material would
include a list of potentially permitted
transactions as examples of transactions
that, depending upon the
circumstances, may be unrelated to the
customer block order. These types of
transactions could include transactions
where the member has effective
information barriers established to
prevent internal disclosure of customer
However, FINRA proposes to expand the rule to
include related financial instruments that may not
result in publicly available trading information
being made available. Accordingly, FINRA also
proposes that the prohibitions in the rule be in
place until the material, non-public market
information is either publicly available or ‘‘has
otherwise become stale or obsolete.’’ Whether
information has become stale or obsolete will
depend upon the particular facts and circumstances
involved, including specific information the
member has regarding the transaction, but could
include factors such as the amount of time that has
passed since the member learned of the block
transaction, subsequent trading activity in the
security, or a significant change in market
conditions.
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order information,14 transactions in the
security that is the subject of the
customer block order that are related to
a prior customer order in that security,
transactions to correct bona fide errors,
and transactions to offset odd-lot orders.
Second, with respect to transactions
undertaken to fulfill or facilitate the
execution of the customer block order,
proposed Supplementary Material .04(b)
would specify that Front Running
Policy does not preclude transactions
undertaken for the purpose of fulfilling,
or facilitating the execution of, a
customer’s block order.15 According to
FINRA, firms are permitted to trade
ahead of a customer’s block order when
the purpose of such trading is to fulfill
the customer order and when the
customer has authorized such trading,
including that the firm has disclosed to
the customer that it may trade ahead of,
or alongside of, the customer’s order.
FINRA proposes, however, that when
engaging in trading activity that could
affect the market for the security that is
the subject of the customer block order,
the member must minimize any
potential disadvantage or harm in the
execution of the customer’s order, must
not place the member’s financial
interests ahead of those of its customer,
and must obtain the customer’s consent
to such trading activity. The
Supplementary Material would provide
that a member may obtain consent
through affirmative written consent or
through means of a negative consent
letter.16 In addition, a member may
provide clear and comprehensive oral
disclosure to, and obtain consent from,
the customer on an order-by-order basis,
14 According to FINRA, in addition to more
traditional information barriers, such as those in
place to prevent communication between trading
units, this provision could also include the use of
automated systems (e.g., trades through a ‘‘black
box’’) where the orders placed into the automated
system are handled without the knowledge of a
person associated with the member who may be
trading in the same security. However, a person
associated with a member who places an order into
a ‘‘black box’’ or other automated system, or
otherwise has knowledge of the order or the ability
to access information in the system, may not then
trade in the same security or a related financial
instrument solely because the order ultimately was
being handled by the automated system rather than
by the person. Traders who have no knowledge of
the order, due to the presence of an information
barrier or otherwise, could continue to trade in the
security or a related financial instrument. See
Notice, supra note 3.
15 According to FINRA, these transactions may
include, for example, hedging or other positioning
activity undertaken in connection with the
handling of the customer order. See Notice, supra
note 3.
16 The negative consent letter must clearly
disclose to the customer the terms and conditions
for handling the customer’s orders, and if the
customer does not object, then the member may
reasonably conclude that the customer has
consented and may rely on the letter.
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Fmt 4703
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55521
provided the member documents who
provided the consent and such consent
evidences the customer’s understanding
of the terms and conditions for handling
the customer’s order.
Finally, proposed Supplementary
Material .04(c) would state that the
prohibitions in the Front Running
Policy shall not apply if the member’s
trading activity is undertaken in
compliance with the marketplace rules
of a national securities exchange and at
least one leg of the trading activity is
executed on that exchange.
3. Other Proposed Changes
FINRA proposes to adopt proposed
Supplementary Material .05 to state that
the front running of any customer order,
not just imminent block transactions,
that places the financial interests of the
member ahead of those of its customer
or the misuse of knowledge of an
imminent customer order may violate
other FINRA rules, including FINRA
Rules 2010 and 5320, or the federal
securities laws.17
As initially proposed, FINRA would
announce the implementation date of
the proposed rule change in a
Regulatory Notice to be published no
later than 90 days following
Commission approval, with the
implementation date occurring no later
than 90 days following publication of
that Regulatory Notice.18
III. Discussion of Comment Letters and
FINRA Response
The Commission received one
comment letter in support of the
proposed rule change,19 and one
comment letter requesting revisions and
clarifications to the proposed rule
change.20 As noted above, FINRA
responded to the comments in its
response dated August 29, 2012.
One commenter stated its belief that
the extension of the Front Running
Policy to cover any securities and
financial instruments (not just option
contracts and futures) was a logical
approach and would better protect
investors.21 The commenter expressed
concern with the exceptions provided in
the Supplementary Material, and stated
that FINRA should closely monitor the
17 Although ‘‘not held’’ orders are not subject to
the restrictions in FINRA Rule 5320, front running
a ‘‘not held’’ order that is not of block size may
nonetheless violate FINRA Rule 2010. See
Securities Exchange Act Release No. 63895
(February 11, 2011), 76 FR 9386 (February 17,
2011). If the ‘‘not held’’ order is of block size, the
proposed rule change would apply to trading
activity ahead of the order.
18 See FINRA Response, supra note 5.
19 See PIABA Letter, supra note 4.
20 See SIFMA Letter, supra note 4.
21 See PIABA Letter.
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exceptions to ensure member firms are
not using them as loopholes to engage
in prohibited activities. In its response,
FINRA stated that it intends to examine
firms for compliance with, and fully
enforce, the proposed rule.22
The other commenter raised three
substantive issues with the proposal.23
First, the commenter stated that the
proposed rule change contained a flaw
in that the barriers to the resumption of
trading in the applicable security or
related financial instrument—that the
information concerning the block
transaction has been made publicly
available or has otherwise become stale
or obsolete—could interfere with a
broker-dealers’ risk management
activity, which could create problems in
providing liquidity to the market.24 The
commenter requested clarity on what
serves as the trigger for lifting trading
restrictions and stated that trading
restrictions should be lifted once the
risk of a transaction has been transferred
from the customer through the
execution of the order.25 According to
the commenter, in the context of a block
transaction where a member executes as
a principal, the member provides
liquidity to the market and is assuming
the risks of the transaction. While
executing a block transaction in an
agency capacity, a member cannot trade
ahead of its customer because the
execution of the transaction eliminates
the opportunity to do so. In certain
situations where a type of security is not
subject to prompt last sale reporting
requirements, the commenter stated that
the ‘‘stale or obsolete’’ threshold
proposed by FINRA could prevent a
dealer from performing necessary risk
management activities while providing
no additional benefit to the customer.
Accordingly, the commenter requested
confirmation that the execution of a
block transaction by the member as
principal or agent will be deemed to
render the non-public information stale
and obsolete for the purposes of frontrunning the customer, and permit the
broker-dealer to transact in the security
or related financial instrument, even if
the applicable customer-related
transaction has not become public.
FINRA responded that the ‘‘stale or
obsolete’’ standard was intended to
supplement, not replace, the existing
dissemination standard.26 FINRA noted
22 See
FINRA Response.
SIFMA Letter.
24 See SIFMA Letter.
25 Id.
26 Under NASD IM–2110–3, information
regarding a block transaction is considered publicly
available ‘‘when it has been disseminated via the
tape or high speed communications line of one of
those systems, a similar system of a national
23 See
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that the trading restrictions in proposed
FINRA Rule 5270 are linked to actual
reporting and dissemination rather than
by invoking the ‘‘stale or obsolete’’
standard when transactions are subject
to prompt reporting requirements and
the transaction reports are disseminated.
Where there is no reporting and
dissemination regime in place for the
security or financial instrument, FINRA
agreed with the commenter that, once
the customer’s order is executed and the
risk of the transaction has transferred
from the customer to the firm, there
would be no trading restrictions
imposed by proposed FINRA Rule
5270.27
Second, the commenter requested
additional clarification on whether the
negative consent letter described in
proposed Supplementary Material .04
would satisfy and be consistent with the
‘‘duty to refrain and disclose’’ described
in NASD Notice to Members 05–51
(‘‘NTM 05–51’’) and FINRA Rule
5320.28 Additionally, the commenter
requested clarity on whether the duty to
refrain and disclose described in NTM
05–51 29 arises on the basis of the same
analysis as the obligations under
proposed FINRA Rule 5270.
In its response, FINRA agreed that, to
the extent possible, proposed
Supplementary Material .04 should be
read consistently with NTM 05–51 and
the obligations set out in FINRA Rule
5320.30 FINRA stated that the proposed
Supplementary Material was intended
to acknowledge FINRA’s previous
guidance and the disclosure and
consent provision in proposed
Supplementary Material .04 mirrors
securities exchange under Section 6 of the Act, an
alternative trading system under Regulation ATS, or
by a third-party news wire service.’’
27 See FINRA Response at 3.
28 FINRA Rule 5320 (Prohibition Against Trading
Ahead of Customer Orders) generally prohibits a
member that accepts and holds a customer order in
an equity security without immediately executing
the order from trading that security on the same
side of the market for its own account at a price that
would satisfy the customer order, unless it
immediately thereafter executes the customer order
up to the size and at the same or better price at
which it traded for its own account.
29 NTM 05–51 addresses members’ obligations
involving large, potentially market-moving orders
received from a customer, such as VWAPs,
institutional orders, and basket transactions. It
states that, when a member receives such an order,
it must ‘‘(1) refrain from any conduct that could
disadvantage or harm the execution of the
customer’s order or place the member’s financial
interests ahead of those of its customer’s and (2) if
applicable, disclose in writing to the customer that
the member intends to engage in hedging and other
positioning activity that could affect the market for
the security that is the subject of the transaction.’’
It further states that the disclosure must be in the
form of an affirmative consent letter, but the
disclosure need not be on a transaction-bytransaction basis.
30 See FINRA Response at 4.
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FINRA Rule 5320. Moreover, FINRA
stated that the duties set out in NTM
05–51 arise from the same concerns that
FINRA Rule 5270 is designed to
address. FINRA affirmed that proposal
encapsulates the obligations established
in NTM 05–51 with the difference noted
by SIFMA: the disclosure obligation in
proposed Supplementary Material .04
can be in the form of negative consent
or, provided certain criteria are met, oral
consent, which is not permitted by the
duty to refrain and disclose as set out in
NTM 05–51. FINRA further noted that,
in addition to complying with the
disclosure obligation in proposed
Supplementary Material .04, the
member must minimize any potential
disadvantage to the customer or harm in
the execution of the customer’s order,
and the member must not place its
financial interests ahead of those of its
customer. FINRA stated that, provided a
member meets all of the criteria in
proposed Supplementary Material .04,
that member would have fulfilled its
duty to refrain and disclose as set out in
the Notice to Members.
Finally, the commenter requested a
180-day implementation period
following publication of the applicable
Regulatory Notice announcing the
Commission’s approval of the proposal,
rather than a 90-day implementation
period, because members will need to
make additional technology and system
modifications to comply with the rule.31
FINRA responded that it would extend
the implementation date to within 180
days following publication of the
Regulatory Notice announcing the
Commission’s approval of the rule.32
IV. Discussion and Commission
Findings
After careful review of the proposal,
the comment letters, and the FINRA
Response, the Commission finds that
the proposed rule change is consistent
with the requirements of the Act and the
rules and regulations thereunder
applicable to a national securities
association 33 and, in particular, the
requirements 15A(b)(6) of the Act.34
Specifically, the Commission finds that
the proposed rule change is designed to
prevent fraudulent and manipulative
acts and practices, to promote just and
equitable principles of trade, to remove
impediments to and perfect the
mechanism of a free and open market
and a national market system, and, in
31 See
SIFMA Letter at 4.
FINRA Response at 5.
33 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).
34 15 U.S.C. 78o–3(b)(6).
32 See
E:\FR\FM\10SEN1.SGM
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mstockstill on DSK4VPTVN1PROD with NOTICES
Federal Register / Vol. 77, No. 175 / Monday, September 10, 2012 / Notices
general, to protect investors and the
public interest.
The proposed rule change is intended
to clarify the types of front running
trading activity that FINRA believes are
inconsistent with just and equitable
principles of trade while also ensuring
that members may continue to engage in
transactions that do not present the risk
of abusive trading practices that the rule
is intended to prevent. The Commission
finds that expanding the rule beyond
options and security futures could
enhance the protection of investors by
further prohibiting the potential misuse
of information from customer orders.
Expanding the front running prohibition
is reasonably designed to prevent
fraudulent and manipulative acts and
practices, promote just and equitable
principles of trade, and better protect
investors and the public interest, while
protecting imminent block transactions.
Moreover, the proposed rule change
also would include three exceptions to
the Front Running Policy: (1)
Transactions that the member can
demonstrate are unrelated to the
customer block order; (2) transactions
that are undertaken to fulfill or facilitate
the execution of the customer block
order; and (3) transactions that are
executed, in whole or in part, on a
national securities exchange and
comply with the marketplace rules of
that exchange. The Commission finds
that these exceptions should not
unnecessarily restrict legitimate trading
activities of members and are consistent
with just and equitable principles of
trade and the protection of investors and
the public interest, and should not
result in fraudulent and manipulative
acts and practices. Specifically,
transactions that the member can
demonstrate are unrelated to the
customer block order do not present the
potential for abusive trading practices
that can disadvantage a customer’s order
in violation of the rule, since such
transactions would not be using the
information from the customer’s order.
Moreover, transactions that are
undertaken to fulfill or facilitate the
execution of the customer block order
similarly do not present the potential for
abuse, as such transactions would be
seeking to ensure the execution of a
customer block order. Finally,
permitting transactions that are
executed, in whole or in part, on a
national securities exchange and
comply with the marketplace rules of
that exchange would remove
impediments to and perfect the
mechanism of a free and open market
and a national market system,35 as it
would help ensure that members would
not unknowingly violate FINRA rules
when such members rely on the rules of
a particular national securities
exchange.
For the foregoing reasons, the
Commission believes that the proposed
rule change, as modified by Amendment
No. 1, is consistent with the
requirements of the Act.
listed above or other locally announced
locations.
The following areas have been
determined to be adversely affected by
the disaster:
Primary Counties: Lincoln, Sandoval,
and the Santa Clara Pueblo.
The Interest Rates are:
V. Conclusion
For Physical Damage:
Non-Profit Organizations With
Credit Available Elsewhere
Non-Profit
Organizations
Without Credit Available
Elsewhere ..........................
For Economic Injury:
Non-Profit
Organizations
Without Credit Available
Elsewhere ..........................
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,36 that the
proposed rule change (SR–FINRA–
2012–025), as modified by Amendment
No. 1, be, and hereby is, approved.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.37
Kevin M. O’Neill,
Deputy Secretary.
[FR Doc. 2012–22139 Filed 9–7–12; 8:45 am]
BILLING CODE 8011–01–P
U.S.C. 78o–3(b)(6).
VerDate Mar<15>2010
16:57 Sep 07, 2012
SMALL BUSINESS ADMINISTRATION
3.125
3.000
3.000
The number assigned to this disaster
for physical damage is 132526 and for
economic injury is 132536.
[Disaster Declaration #13252 and #13253]
James E. Rivera,
Associate Administrator for Disaster
Assistance.
New Mexico Disaster #NM–00029
[FR Doc. 2012–22199 Filed 9–7–12; 8:45 am]
U.S. Small Business
Administration.
ACTION: Notice.
BILLING CODE 8025–01–P
AGENCY:
DEPARTMENT OF STATE
This is a Notice of the
Presidential declaration of a major
disaster for Public Assistance Only for
the State of New Mexico (FEMA–4079–
DR), dated 08/24/2012.
Incident: Flooding.
Incident Period: 06/22/2012 through
07/12/2012.
Effective Date: 08/24/2012.
Physical Loan Application Deadline
Date: 10/23/2012.
Economic Injury (EIDL) Loan
Application Deadline Date: 05/24/2013.
ADDRESSES: Submit completed loan
applications to: U.S. Small Business
Administration, Processing and
Disbursement Center, 14925 Kingsport
Road, Fort Worth, TX 76155.
FOR FURTHER INFORMATION CONTACT: A.
Escobar, Office of Disaster Assistance,
U.S. Small Business Administration,
409 3rd Street SW., Suite 6050,
Washington, DC 20416.
SUPPLEMENTARY INFORMATION: Notice is
hereby given that as a result of the
President’s major disaster declaration on
08/24/2012, Private Non-Profit
organizations that provide essential
services of governmental nature may file
disaster loan applications at the address
SUMMARY:
37 17
Jkt 226001
Percent
(Catalog of Federal Domestic Assistance
Numbers 59002 and 59008)
36 15
35 15
55523
PO 00000
U.S.C. 78s(b)(2).
CFR 200.30–3(a)(12).
Frm 00073
Fmt 4703
Sfmt 4703
[Public Notice 8017]
60-Day Notice of Proposed Information
Collection: Application for
Employment as a Locally Employed
Staff or Family Member
Notice of request for public
comment.
ACTION:
The Department of State is
seeking Office of Management and
Budget (OMB) approval for the
information collection described below.
In accordance with the Paperwork
Reduction Act of 1995, we are
requesting comments on this collection
from all interested individuals and
organizations. The purpose of this
notice is to allow 60 days for public
comment preceding submission of the
collection to OMB.
DATES: The Department will accept
comments from the public up to
November 9, 2012.
ADDRESSES: You may submit comments
by any of the following methods:
• Web: Persons with access to the
Internet may use the Federal Docket
Management System (FDMS) to
comment on this notice by going to
www.Regulations.gov. You can search
for the document by entering ‘‘Public
SUMMARY:
E:\FR\FM\10SEN1.SGM
10SEN1
]]>Agencies
[Federal Register Volume 77, Number 175 (Monday, September 10, 2012)]
[Notices]
[Pages 55519-55523]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-22139]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-67774; File No. SR-FINRA-2012-025]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Approving Proposed Rule Change, as Modified by
Amendment No. 1, To Adopt Existing NASD IM-2110-3 as New FINRA Rule
5270 (Front Running of Block Transactions) With Changes in the
Consolidated FINRA Rulebook
September 4, 2012.
I. Introduction
On May 17, 2012, Financial Industry Regulatory Authority, Inc.
(``FINRA'') (f/
[[Page 55520]]
k/a National Association of Securities Dealers, Inc. (``NASD'')) filed
with the Securities and Exchange Commission (``Commission''), pursuant
to Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'')
\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to adopt
existing NASD Interpretive Material (``IM'') 2110-3 (Front Running
Policy) as proposed FINRA Rule 5270 to amend the existing Front Running
Policy in several ways to broaden its scope and provide further clarity
into activities that FINRA believes are inconsistent with just and
equitable principles of trade. The proposed rule change was published
for comment in the Federal Register on June 6, 2012.\3\ The Commission
received two comment letters on the proposed rule change,\4\ and a
response to comments from FINRA.\5\ On August 30, 2012, FINRA submitted
Amendment No. 1 to the proposal.\6\ This order approves the proposed
rule change, as modified by Amendment No. 1.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 67079 (May 30,
2012), 77 FR 33522 (``Notice'').
\4\ See Letters to Elizabeth M. Murphy, Secretary, Commission,
from Ryan K. Bakhtiari, President, Public Investors Arbitration Bar
Association (``PIABA''), dated June 26, 2012 (``PIABA Letter''); and
Sean Davy, Managing Director, Corporate Credit Markets Division,
Securities Industry and Financial Markets Association (``SIFMA''),
dated July 9, 2012 (``SIFMA Letter'').
\5\ See Letter from Brant K. Brown, Associate General Counsel,
FINRA, to Elizabeth M. Murphy, Secretary, Commission, dated August
29, 2012 (``FINRA Response'').
\6\ In that amendment, FINRA clarified that the proposed rule
would not apply to orders or transactions involving government
securities. FINRA noted, however, that actions for similar front-
running conduct occurring in the exempted securities markets,
including the government securities market, continue to be covered
by FINRA Rule 2010. In the amendment, FINRA also clarified that the
10,000 share language in proposed Supplementary Material .03 refers
to equity securities. Because this amendment is technical in nature,
it is not subject to notice and comment.
---------------------------------------------------------------------------
II. Description of the Proposal
As part of the process of developing a consolidated rulebook,\7\
FINRA proposed to adopt existing NASD IM-2110-3 (``Front Running
Policy'') as proposed FINRA Rule 5270 with the changes described below.
---------------------------------------------------------------------------
\7\ The FINRA rulebook consists of: (1) FINRA Rules; (2) NASD
Rules; and (3) rules incorporated from NYSE (``Incorporated NYSE
Rules'') (together, the NASD Rules and Incorporated NYSE Rules are
referred to as the ``Transitional Rulebook''). While the NASD Rules
generally apply to all FINRA members, the Incorporated NYSE Rules
apply only to those members of FINRA that are also members of the
NYSE (``Dual Members''). The FINRA Rules apply to all FINRA members,
unless such rules have a more limited application by their terms.
See FINRA Information Notice, March 12, 2008 (Rulebook Consolidation
Process).
---------------------------------------------------------------------------
A. Current Front Running Policy
The current Front Running Policy states that it shall be considered
conduct inconsistent with just and equitable principles of trade for a
member or a person associated with a member, for an account in which
such member or person associated with a member has an interest or
exercises investment discretion or for certain customer accounts, to
buy or sell an option or security future when the member or person
associated with a member has material, non-public market information
concerning an imminent block transaction \8\ in the underlying security
or when the customer has been provided such material, non-public market
information by the member of any person associated with a member.\9\
Similarly, the same prohibition applies for a member or any person
associated with a member with respect to an order to buy or sell an
underlying security when such member or person associated with a member
causing such order to be executed has material, non-public market
information concerning an imminent block transaction in an option or a
security future overlying that security, or when a customer has been
provided such material, non-public market information by the member or
any person associated with a member; prior to the time information
concerning the block transaction has been made publicly available.\10\
---------------------------------------------------------------------------
\8\ NASD IM-2110-3 states that ``[a] transaction involving
10,000 shares or more of an underlying security, or options or
security futures covering such number of shares is generally deemed
to be a block transaction, although a transaction of less than
10,000 shares could be considered a block transaction in appropriate
cases.''
\9\ See NASD IM-2110-3(a).
\10\ See NASD IM-2110-3(b).
---------------------------------------------------------------------------
The Front Running Policy also prohibits providing material, non-
public market information concerning an imminent block transaction to
customers who then trade on the basis of the information. The Front
Running Policy is limited to transactions in equity securities and
options that are required to be reported on a last sale reporting
system and to any transaction involving a security future, regardless
of whether the transaction is reported. The prohibitions apply until
the information concerning the block transaction has been made publicly
available.\11\
---------------------------------------------------------------------------
\11\ See NASD IM-2110-3 (``when [the information] has been
disseminated via the tape or high speed communications line of one
of those systems, a similar system of a national securities exchange
under Section 6 of the Act, an alternative trading system under
Regulation ATS, or by a third-party news wire service'').
---------------------------------------------------------------------------
Finally, the Front Running Policy includes exceptions for
``transactions executed by member participants in automatic execution
systems in those instances where participants must accept automatic
executions'' as well as situations where a member receives a customer's
block order relating to both an option or security future and the
underlying security and the member, in furtherance of facilitating the
customer's block order, positions the other side of one or both
components of the order. In the latter case, a member is still
prohibited from covering any resulting proprietary position by entering
an offsetting order until information concerning the block transaction
has been made publicly available.
B. Proposed Changes to Front Running Policy
1. Expansion of the Front Running Policy
FINRA proposes to expand the Front Running Policy to apply to all
securities and other financial instruments and contracts (in addition
to the existing options and security futures) that overlay the security
that is the subject of an imminent block transaction and that have a
value that is materially related to, or otherwise acts as a substitute
for, the underlying security. Specifically, FINRA proposes to expand
the Front Running Policy to cover trading in an option, derivative,
security-based swap, or other financial instrument overlying a security
that is the subject of an imminent block transaction if the value of
the underlying security is materially related to, or otherwise acts as
a substitute for, such security, as well as any contract that is the
functional economic equivalent of a position in such security
(``related financial instrument'').\12\
---------------------------------------------------------------------------
\12\ FINRA notes that the proposed rule is not intended to
provide an exhaustive list of prohibited trading activity. See
Notice, supra note 3.
---------------------------------------------------------------------------
The proposal would also expand the Front Running Policy when the
imminent block transaction involves a related financial instrument, and
prevent trading in the underlying security. The proposed rule change
also would extend the Front Running Policy to include explicitly
trading in the same security or related financial instrument that is
the subject of an imminent block transaction.\13\
---------------------------------------------------------------------------
\13\ The trading restrictions imposed by the current Front
Running Policy apply until information about the imminent customer
block transaction ``has been made publicly available,'' which the
rule defines as having been disseminated to the public in trade
reporting data. The proposed rule change generally retains this
standard for determining when information has become publicly
available. However, FINRA proposes to expand the rule to include
related financial instruments that may not result in publicly
available trading information being made available. Accordingly,
FINRA also proposes that the prohibitions in the rule be in place
until the material, non-public market information is either publicly
available or ``has otherwise become stale or obsolete.'' Whether
information has become stale or obsolete will depend upon the
particular facts and circumstances involved, including specific
information the member has regarding the transaction, but could
include factors such as the amount of time that has passed since the
member learned of the block transaction, subsequent trading activity
in the security, or a significant change in market conditions.
---------------------------------------------------------------------------
[[Page 55521]]
2. Amended Exceptions to the Front Running Policy
The proposed rule change would replace several existing provisions
in the Front Running Policy with proposed Supplementary Material to
FINRA Rule 5270. FINRA proposes to replace the existing exceptions in
the Front Running Policy for certain transactions in automatic
execution systems and for positioning the other side of certain orders
when a member receives a customer's block order relating to both an
option and the underlying security or both a security future and the
underlying security. The new Supplementary Material identifies types of
transactions that are permitted. Specifically, under the proposed
Supplementary Material, there would be three broad categories of
permitted transactions: (1) Transactions that the member can
demonstrate are unrelated to the customer block order; (2) transactions
that are undertaken to fulfill or facilitate the execution of the
customer block order; or (3) transactions that are executed, in whole
or in part, on a national securities exchange and comply with the
marketplace rules of that exchange. These three categories of permitted
transactions are discussed below.
First, with respect to transactions that are unrelated to the
customer block order, Supplementary Material .04(a) would allow members
to engage in such transactions provided that the member can demonstrate
that the transactions are unrelated to the material, non-public market
information received in connection with the customer order. The
Supplementary Material would include a list of potentially permitted
transactions as examples of transactions that, depending upon the
circumstances, may be unrelated to the customer block order. These
types of transactions could include transactions where the member has
effective information barriers established to prevent internal
disclosure of customer order information,\14\ transactions in the
security that is the subject of the customer block order that are
related to a prior customer order in that security, transactions to
correct bona fide errors, and transactions to offset odd-lot orders.
---------------------------------------------------------------------------
\14\ According to FINRA, in addition to more traditional
information barriers, such as those in place to prevent
communication between trading units, this provision could also
include the use of automated systems (e.g., trades through a ``black
box'') where the orders placed into the automated system are handled
without the knowledge of a person associated with the member who may
be trading in the same security. However, a person associated with a
member who places an order into a ``black box'' or other automated
system, or otherwise has knowledge of the order or the ability to
access information in the system, may not then trade in the same
security or a related financial instrument solely because the order
ultimately was being handled by the automated system rather than by
the person. Traders who have no knowledge of the order, due to the
presence of an information barrier or otherwise, could continue to
trade in the security or a related financial instrument. See Notice,
supra note 3.
---------------------------------------------------------------------------
Second, with respect to transactions undertaken to fulfill or
facilitate the execution of the customer block order, proposed
Supplementary Material .04(b) would specify that Front Running Policy
does not preclude transactions undertaken for the purpose of
fulfilling, or facilitating the execution of, a customer's block
order.\15\ According to FINRA, firms are permitted to trade ahead of a
customer's block order when the purpose of such trading is to fulfill
the customer order and when the customer has authorized such trading,
including that the firm has disclosed to the customer that it may trade
ahead of, or alongside of, the customer's order. FINRA proposes,
however, that when engaging in trading activity that could affect the
market for the security that is the subject of the customer block
order, the member must minimize any potential disadvantage or harm in
the execution of the customer's order, must not place the member's
financial interests ahead of those of its customer, and must obtain the
customer's consent to such trading activity. The Supplementary Material
would provide that a member may obtain consent through affirmative
written consent or through means of a negative consent letter.\16\ In
addition, a member may provide clear and comprehensive oral disclosure
to, and obtain consent from, the customer on an order-by-order basis,
provided the member documents who provided the consent and such consent
evidences the customer's understanding of the terms and conditions for
handling the customer's order.
---------------------------------------------------------------------------
\15\ According to FINRA, these transactions may include, for
example, hedging or other positioning activity undertaken in
connection with the handling of the customer order. See Notice,
supra note 3.
\16\ The negative consent letter must clearly disclose to the
customer the terms and conditions for handling the customer's
orders, and if the customer does not object, then the member may
reasonably conclude that the customer has consented and may rely on
the letter.
---------------------------------------------------------------------------
Finally, proposed Supplementary Material .04(c) would state that
the prohibitions in the Front Running Policy shall not apply if the
member's trading activity is undertaken in compliance with the
marketplace rules of a national securities exchange and at least one
leg of the trading activity is executed on that exchange.
3. Other Proposed Changes
FINRA proposes to adopt proposed Supplementary Material .05 to
state that the front running of any customer order, not just imminent
block transactions, that places the financial interests of the member
ahead of those of its customer or the misuse of knowledge of an
imminent customer order may violate other FINRA rules, including FINRA
Rules 2010 and 5320, or the federal securities laws.\17\
---------------------------------------------------------------------------
\17\ Although ``not held'' orders are not subject to the
restrictions in FINRA Rule 5320, front running a ``not held'' order
that is not of block size may nonetheless violate FINRA Rule 2010.
See Securities Exchange Act Release No. 63895 (February 11, 2011),
76 FR 9386 (February 17, 2011). If the ``not held'' order is of
block size, the proposed rule change would apply to trading activity
ahead of the order.
---------------------------------------------------------------------------
As initially proposed, FINRA would announce the implementation date
of the proposed rule change in a Regulatory Notice to be published no
later than 90 days following Commission approval, with the
implementation date occurring no later than 90 days following
publication of that Regulatory Notice.\18\
---------------------------------------------------------------------------
\18\ See FINRA Response, supra note 5.
---------------------------------------------------------------------------
III. Discussion of Comment Letters and FINRA Response
The Commission received one comment letter in support of the
proposed rule change,\19\ and one comment letter requesting revisions
and clarifications to the proposed rule change.\20\ As noted above,
FINRA responded to the comments in its response dated August 29, 2012.
---------------------------------------------------------------------------
\19\ See PIABA Letter, supra note 4.
\20\ See SIFMA Letter, supra note 4.
---------------------------------------------------------------------------
One commenter stated its belief that the extension of the Front
Running Policy to cover any securities and financial instruments (not
just option contracts and futures) was a logical approach and would
better protect investors.\21\ The commenter expressed concern with the
exceptions provided in the Supplementary Material, and stated that
FINRA should closely monitor the
[[Page 55522]]
exceptions to ensure member firms are not using them as loopholes to
engage in prohibited activities. In its response, FINRA stated that it
intends to examine firms for compliance with, and fully enforce, the
proposed rule.\22\
---------------------------------------------------------------------------
\21\ See PIABA Letter.
\22\ See FINRA Response.
---------------------------------------------------------------------------
The other commenter raised three substantive issues with the
proposal.\23\ First, the commenter stated that the proposed rule change
contained a flaw in that the barriers to the resumption of trading in
the applicable security or related financial instrument--that the
information concerning the block transaction has been made publicly
available or has otherwise become stale or obsolete--could interfere
with a broker-dealers' risk management activity, which could create
problems in providing liquidity to the market.\24\ The commenter
requested clarity on what serves as the trigger for lifting trading
restrictions and stated that trading restrictions should be lifted once
the risk of a transaction has been transferred from the customer
through the execution of the order.\25\ According to the commenter, in
the context of a block transaction where a member executes as a
principal, the member provides liquidity to the market and is assuming
the risks of the transaction. While executing a block transaction in an
agency capacity, a member cannot trade ahead of its customer because
the execution of the transaction eliminates the opportunity to do so.
In certain situations where a type of security is not subject to prompt
last sale reporting requirements, the commenter stated that the ``stale
or obsolete'' threshold proposed by FINRA could prevent a dealer from
performing necessary risk management activities while providing no
additional benefit to the customer. Accordingly, the commenter
requested confirmation that the execution of a block transaction by the
member as principal or agent will be deemed to render the non-public
information stale and obsolete for the purposes of front-running the
customer, and permit the broker-dealer to transact in the security or
related financial instrument, even if the applicable customer-related
transaction has not become public.
---------------------------------------------------------------------------
\23\ See SIFMA Letter.
\24\ See SIFMA Letter.
\25\ Id.
---------------------------------------------------------------------------
FINRA responded that the ``stale or obsolete'' standard was
intended to supplement, not replace, the existing dissemination
standard.\26\ FINRA noted that the trading restrictions in proposed
FINRA Rule 5270 are linked to actual reporting and dissemination rather
than by invoking the ``stale or obsolete'' standard when transactions
are subject to prompt reporting requirements and the transaction
reports are disseminated. Where there is no reporting and dissemination
regime in place for the security or financial instrument, FINRA agreed
with the commenter that, once the customer's order is executed and the
risk of the transaction has transferred from the customer to the firm,
there would be no trading restrictions imposed by proposed FINRA Rule
5270.\27\
---------------------------------------------------------------------------
\26\ Under NASD IM-2110-3, information regarding a block
transaction is considered publicly available ``when it has been
disseminated via the tape or high speed communications line of one
of those systems, a similar system of a national securities exchange
under Section 6 of the Act, an alternative trading system under
Regulation ATS, or by a third-party news wire service.''
\27\ See FINRA Response at 3.
---------------------------------------------------------------------------
Second, the commenter requested additional clarification on whether
the negative consent letter described in proposed Supplementary
Material .04 would satisfy and be consistent with the ``duty to refrain
and disclose'' described in NASD Notice to Members 05-51 (``NTM 05-
51'') and FINRA Rule 5320.\28\ Additionally, the commenter requested
clarity on whether the duty to refrain and disclose described in NTM
05-51 \29\ arises on the basis of the same analysis as the obligations
under proposed FINRA Rule 5270.
---------------------------------------------------------------------------
\28\ FINRA Rule 5320 (Prohibition Against Trading Ahead of
Customer Orders) generally prohibits a member that accepts and holds
a customer order in an equity security without immediately executing
the order from trading that security on the same side of the market
for its own account at a price that would satisfy the customer
order, unless it immediately thereafter executes the customer order
up to the size and at the same or better price at which it traded
for its own account.
\29\ NTM 05-51 addresses members' obligations involving large,
potentially market-moving orders received from a customer, such as
VWAPs, institutional orders, and basket transactions. It states
that, when a member receives such an order, it must ``(1) refrain
from any conduct that could disadvantage or harm the execution of
the customer's order or place the member's financial interests ahead
of those of its customer's and (2) if applicable, disclose in
writing to the customer that the member intends to engage in hedging
and other positioning activity that could affect the market for the
security that is the subject of the transaction.'' It further states
that the disclosure must be in the form of an affirmative consent
letter, but the disclosure need not be on a transaction-by-
transaction basis.
---------------------------------------------------------------------------
In its response, FINRA agreed that, to the extent possible,
proposed Supplementary Material .04 should be read consistently with
NTM 05-51 and the obligations set out in FINRA Rule 5320.\30\ FINRA
stated that the proposed Supplementary Material was intended to
acknowledge FINRA's previous guidance and the disclosure and consent
provision in proposed Supplementary Material .04 mirrors FINRA Rule
5320. Moreover, FINRA stated that the duties set out in NTM 05-51 arise
from the same concerns that FINRA Rule 5270 is designed to address.
FINRA affirmed that proposal encapsulates the obligations established
in NTM 05-51 with the difference noted by SIFMA: the disclosure
obligation in proposed Supplementary Material .04 can be in the form of
negative consent or, provided certain criteria are met, oral consent,
which is not permitted by the duty to refrain and disclose as set out
in NTM 05-51. FINRA further noted that, in addition to complying with
the disclosure obligation in proposed Supplementary Material .04, the
member must minimize any potential disadvantage to the customer or harm
in the execution of the customer's order, and the member must not place
its financial interests ahead of those of its customer. FINRA stated
that, provided a member meets all of the criteria in proposed
Supplementary Material .04, that member would have fulfilled its duty
to refrain and disclose as set out in the Notice to Members.
---------------------------------------------------------------------------
\30\ See FINRA Response at 4.
---------------------------------------------------------------------------
Finally, the commenter requested a 180-day implementation period
following publication of the applicable Regulatory Notice announcing
the Commission's approval of the proposal, rather than a 90-day
implementation period, because members will need to make additional
technology and system modifications to comply with the rule.\31\ FINRA
responded that it would extend the implementation date to within 180
days following publication of the Regulatory Notice announcing the
Commission's approval of the rule.\32\
---------------------------------------------------------------------------
\31\ See SIFMA Letter at 4.
\32\ See FINRA Response at 5.
---------------------------------------------------------------------------
IV. Discussion and Commission Findings
After careful review of the proposal, the comment letters, and the
FINRA Response, the Commission finds that the proposed rule change is
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities association
\33\ and, in particular, the requirements 15A(b)(6) of the Act.\34\
Specifically, the Commission finds that the proposed rule change is
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, to remove impediments
to and perfect the mechanism of a free and open market and a national
market system, and, in
[[Page 55523]]
general, to protect investors and the public interest.
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\33\ 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).
\34\ 15 U.S.C. 78o-3(b)(6).
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The proposed rule change is intended to clarify the types of front
running trading activity that FINRA believes are inconsistent with just
and equitable principles of trade while also ensuring that members may
continue to engage in transactions that do not present the risk of
abusive trading practices that the rule is intended to prevent. The
Commission finds that expanding the rule beyond options and security
futures could enhance the protection of investors by further
prohibiting the potential misuse of information from customer orders.
Expanding the front running prohibition is reasonably designed to
prevent fraudulent and manipulative acts and practices, promote just
and equitable principles of trade, and better protect investors and the
public interest, while protecting imminent block transactions.
Moreover, the proposed rule change also would include three
exceptions to the Front Running Policy: (1) Transactions that the
member can demonstrate are unrelated to the customer block order; (2)
transactions that are undertaken to fulfill or facilitate the execution
of the customer block order; and (3) transactions that are executed, in
whole or in part, on a national securities exchange and comply with the
marketplace rules of that exchange. The Commission finds that these
exceptions should not unnecessarily restrict legitimate trading
activities of members and are consistent with just and equitable
principles of trade and the protection of investors and the public
interest, and should not result in fraudulent and manipulative acts and
practices. Specifically, transactions that the member can demonstrate
are unrelated to the customer block order do not present the potential
for abusive trading practices that can disadvantage a customer's order
in violation of the rule, since such transactions would not be using
the information from the customer's order. Moreover, transactions that
are undertaken to fulfill or facilitate the execution of the customer
block order similarly do not present the potential for abuse, as such
transactions would be seeking to ensure the execution of a customer
block order. Finally, permitting transactions that are executed, in
whole or in part, on a national securities exchange and comply with the
marketplace rules of that exchange would remove impediments to and
perfect the mechanism of a free and open market and a national market
system,\35\ as it would help ensure that members would not unknowingly
violate FINRA rules when such members rely on the rules of a particular
national securities exchange.
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\35\ 15 U.S.C. 78o-3(b)(6).
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For the foregoing reasons, the Commission believes that the
proposed rule change, as modified by Amendment No. 1, is consistent
with the requirements of the Act.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\36\ that the proposed rule change (SR-FINRA-2012-025), as modified
by Amendment No. 1, be, and hereby is, approved.
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\36\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\37\
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\37\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-22139 Filed 9-7-12; 8:45 am]
BILLING CODE 8011-01-P
