regulatory organizations; proposed rule changes: National Association of Securities Dealers, Inc.,

[Federal Register: July 30, 1999 (Volume 64, Number 146)]

[Notices]

[Page 41478-41480]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr30jy99-160]

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41647; File No. SR-NASD-98-61]

Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Granting Approval to Proposed Rule Change Relating to Reporting Transactions in Exchange-Listed Securities

July 23, 1999.

1. Introduction

   On August 12, 1998, the National Association of Securities Dealers, Inc. (``NASD'' or ``Association''), through its wholly-owned subsidiary, Nasdaq Stock Market, Inc. (``Nasdaq''), filedwith the Securities and Exchange Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (``Exchange Act''

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   or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to eliminate an unnecessary provision of an NASD rule relating to the reporting of transactions in exchange-listed securities traded in the third market.

   \1\ 15 U.S.C. 78s (b)(1).

   \2\ 17 CFR 240.19b-4.

   The proposed rule change was published for comment in Exchange Act Release No. 40360 (August 25, 1998), 63 FR 46267 (August 31, 1998). No comments were received on the proposal.\3\ This order approves the proposed rule change.

   \3\ Although the Commission did not receive any comments on this specific proposed rule change, the Chicago Stock Exchange (``CHX'') submitted a comment letter on the Commission's proposal to expand the Intermarket Trading System linkage to all listed securities. The CHX's letter questioned the practical effect of the NASD's proposed rule change. Specifically, CHX questioned whether the NASD's proposed rule change truly eliminated the discretionary nature of the current rule. See Letter to Jonathan G. Katz, Secretary, Commission, from Robert H. Forney, President and Chief Executive Officer, CHX, dated August 28, 1998. The NASD responded in December 1998. See Letter to Jonathan G. Katz, Secretary, Commission, from Richard G. Ketchum, President and Chief Operating Officer, NASD, dated December 17, 1998.

2. Description

   The NASD proposes to eliminate an unnecessary provision of its rules applicable to the reporting of transactions in exchange-listed securities. Specifically, NASD Rule 6420(d)(3)(A), which is the general rule requiring NASD members to report all principal transactions in exchange-listed securities in the third market, currently contains language requiring members to report transactions in a manner ``reasonably related to the prevailing market taking into considerations all relevant circumstances * * *.'' Although this provision accompanied a change to the trade reporting rules approved in 1980 (which was intended to make comparable the reporting of third market trades with exchange transactions), Nasdaq believes that this particular language is superfluous in the context of exchange-listed securities and does not serve any meaningful purpose with respect to the trade reporting of these securities.

   Nasdaq believes that the language has served only to promote the misperception that the rule provides flexibility in the manner in which NASD members may report third market transactions. The rule was intended to require third market trades to be reported on a ``gross'' basis, exclusive of any mark-up or mark-down charged to the customer.\4\ Nasdaq believes that this has led to inaccurate trade reporting, and has been used by ITS Participants \5\ as a reason for not extending the NASD's Intermarket Trading System/Computer Assisted Execution System (``ITS/CAES'') link to all exchange-listed securities. Accordingly, Nasdaq believes that the best practice would be to remove the unclear language from the rule.

   \4\ See Exchange Act Release No. 16960 (July 7, 1980), 45 FR 47291 (July 14, 1980) (approving SR-NASD-80-03).

   \5\ ITS is a communications and order routing network linking eight national securities exchanges and the electronic over-the- counter market operated by the NASD. ITS was designated to facilitate intermarket trading in exchange-listed equity securities based on current quotation information emanating from the linked markets. The NASD's computer assisted execution system (``CAES'') enables participating firms to route their orders for listed securities through ITS to obtain executions against quotations of third market makers participating in Nasdaq. The ITS/CAES interface allows participant exchanges and Nasdaq market makers to route commitments to other participant exchange markets for execution.

   Participants to the ITS Plan include the American Stock Exchange LLC, the Boston Stock Exchange, Inc., the Chicago Board Options Exchange, Inc., the CHX, the Cincinnati Stock Exchange, Inc., the NASD, the New York Stock Exchange, Inc. (``NYSE''), the Pacific Exchange, Inc., and the Philadelphia Stock Exchange, Inc. (collectively, ``Participants'').

3. Discussion

   The Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to the Association and, in particular, with the requirements of Section 15A(b)(6).\6\ Section 15A(b) requires that the rules of the 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, clearing, settling, processing information with respect to, and facilitating 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; and are not designed to permit unfair discrimination between customers, issuers, brokers, and dealers.\7\

   \6\ 15 U.S.C. 78o-3(b)(6).

   \7\ See 15 U.S.C. 78o-3. In approving this rule change, the Commission notes that it has considered the proposal's impact on efficiency, competition, and capital formation, consistent with Section 3 of the Act. Id. at 78c(f).

   The Commission also finds that the proposed rule change is consistent with Section 11A of the Act.\8\ Specifically, the Commission finds that the proposed rule change should facilitate the further development of the National Market System by eliminating any confusion regarding the trade reporting responsibilities of third market makers.

   \8\ 15 U.S.C. 78k-1.

   Prior to July 1980, the NASD required that third market makers report transactions to the tape at the ``net'' price to the customer-- that is, inclusive of mark-ups, mark-downs, commission equilavents, or service charges (collectively, ``charges''). In contrast, exchange rules have always required a trade to be reported to the tape at the ``gross'' transaction price--that is, exclusive of charges. In July 1980, the Commission approved an NASD rule change providing that members would be required to report transactions to the tape exclusive of charges. The NASD's rule also allowed members to report prices ``reasonably related to the market, taking into consideration all relevant circumstances. * * *''

   The NASD's proposed rule change deletes the ``reasonably related to the market'' language. The Commission believes that the proposed rule change clarifies that third market makers will no longer have the perceived latitude to determine the price at which exchange-listed securities transactions are reported. The proposed rule change further promotes the comparability of transaction prices reported in the consolidated system and improves the manner in which transaction prices are disclosed to public investors.

   The Commission notes that the ITS Participants have expressed concern that the perceived lack of comparability between the trade reporting require- ments in the third market and those in the exchange markets results in dispa- rate prices and obligations regarding the protection of quotations under the ITS Trade-Through Rule and Block Policy.\9\ The Participants note that the

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   price at which a transaction is reported to the Consolidated Tape System determines whether or not a member in one Participant market who has displayed a better bid or offer within the linked ITS market is entitled to satisfaction as a consequence of an inferior priced transaction reported to the tape in another market. The ITS Participants believe that the current NASD trade reporting rule, containing the ``reasonably related to the market'' provision, provides latitude to NASD members to report a price to the tape different from the execution price confirmed to customers, thereby creating the potential to avoid the Trade-Through Rule.

   \9\ See, e.g., CHX letter; Letter to Jonathan G. Katz, Secretary Commission, from James E. Buck, Senior Vice President and Secretary, NYSE, dated August 31, 1998 (comment letter to File No. 4-208, Exchange Act Release No. 40260 (July 24, 1998), 63 FR 40748 (July 30, 1998) nn.63, 67) (``NYSE letter'').

   A ``trade-through'' occurs when a transaction is effected at a price below the best bid, or above the best prevailing offer. The ITS Trade-Through Rule requires that members of ITS Participant markets avoid initiating a trade-through when purchasing or selling, either as principal or agent, any ITS security on the Participant market or when sending a commitment to trade through ITS. The ITS Block Trade Policy provides that the member who represents a block- size order(s) shall, at the time of execution of the block trade, send, or cause to be sent, through ITS to each participating ITS market center displaying a bid (or offer) superior to the execution price, a commitment to trade at the execution price and for the number of shares displayed with that market center's better-priced bid (or offer). This policy is intended to enable other markets to derive the benefit of the block without breaking it up.

   In its letter to the Commission, CHX asserts that the NASD's proposed rule change does not address the discretionary nature of the NASD's current trade reporting rule because it ``would merely eliminate the standard articulating how to calculate the markup or markdown.'' The NASD responds that it ``fails to see the relevance of the argument that a third market maker could avoid a trade-through by reporting a price within the national best bid and offer while providing a different price to its customer, when that difference must be disclosed to the customer and assessed as a cost of trading on the same basis as any other charge or commission.'' \10\ The NASD further disagrees with the CHX's assertion that the NASD's proposed rule change limits the value of a trade-through rule. CHX argues that a market maker's discretion to report a trade at a prevailing market price at the time of the trade, as long as the customer is made aware of the difference between the reported price and the net price (the markup), enables a market maker to avoid a trade-through. In response, the NASD states that its trade reporting rule emphasizes the value of a trade-through rule by encouraging market participants to provide an execution at a better price than the national best bid or offer. The NASD further believes that such an execution would be ``exactly comparable with orders executed on an exchange where the reported price does not include the broker's commission.'' \11\

   \10\ See NASD letter.

   \11\ See NASD letter.

   The Commission finds that eliminating the ``reasonably related to the market'' language helps to clarify the NASD's trade reporting rule. As the NYSE stated, removal of the ``reasonably related to the prevailing market'' language would resolve its long-standing concern \12\ with the trade reporting issue.\13\ Furthermore, effective surveillance and confirmation disclosure of the charges to the customer should help to enforce these trade reporting obligations.\14\ Specifically, in the event a broker-dealer is acting as principal in a transaction in a reporting security, the confirmation disclosure rule, Exchange Act Rule 10b-10, requires a broker-dealer to disclose to a customer the trade price reported to the Consolidated Tape, the net price to the customer in the transaction, and the difference, if any, between the reported price and the price to the customer. If a broker- dealer is acting as agent for a customer, the member must confirm to the customer the gross trade price (which is the price reported to the Consolidated Tape), and the commission equivalent as well as the net price to the customer.

   \12\ See, e.g., Letter to Jonathan G. Katz, Secretary, Commission, from James E. Buck, Senior Vice President and Secretary, NYSE, dated June 25, 1997.

   \13\ See NYSE letter.

   \14\ See Exchange Act Release No. 18713 (May 6, 1982), 47 FR 20413, 20415 n.13 (May 12, 1982).

4. Conclusion

   It is therefore ordered, pursuant to Section 19(b)(2) of the Act,\15\ that the proposed rule change (SR-NASD-98-61) is approved.

   \15\ 15 U.S.C. 78s(b)(2).

   For the Commission, by the Division of Market Regulation, pursuant to delegated authority.\16\

   \16\ 17 CFR 200.30-3(a)(12).

   Margaret H. McFarland, Deputy Secretary.

   [FR Doc. 99-19488Filed7-29-99; 8:45 am]

   BILLING CODE 8010-01-M