June 8, 2004

Jon Kroeper
First Vice President and
Associate General Counsel
Instinet Group, LLC
3 Times Square
New York, NY 10036

Re: Rule 10a-1; Exemptive Relief under Short Sale Rule

Dear Mr. Kroeper:

In your letter dated June 7, 2004, as supplemented by telephone conversations with the staff, you had requested on behalf of Instinet, LLC ("Instinet"), a registered broker-dealer, an exemption from Rule 10a-1 under the Securities Exchange Act of 1934 ("Exchange Act") for transactions executed through Instinet's Intraday Crossing System ("IDX").

We understand the facts to be as follows:

You state that IDX is an alternative trading system that matches buying and selling interest among institutional investors and broker-dealers at various set times during the day. IDX was designed to meet the special needs of institutional customers, including broker-dealers, who trade in terms of portfolios of stocks by providing an electronic order entry mechanism to facilitate trading in portfolios. IDX also allows participants to enter single stock orders. IDX matches currently are scheduled to occur three times a day ("Regular Matches"), with the pricing of each match occurring at random times during specific one-minute windows from 9:50 to 9:51 a.m.; 11:50 to 11:51 a.m.; and 2:50 to 2:51 p.m.

Instinet clients generally transmit their orders (which are unpriced) by means of electronic interfaces, or by telephone or facsimile to the Instinet trading desk. All orders entered into the system for execution are confidential. The matching and execution of matched orders occurs immediately following the selection of the match price during each one-minute random pricing window. Instinet personnel do not have discretion to delay a match and matches are delayed only to the extent there are technical difficulties with the system. Instinet personnel may not solicit orders from clients or otherwise communicate to clients that a match has not yet occurred during a one-minute match window. All orders involving securities listed on an exchange that are matched by the system during the Regular Matches are priced at the midpoint of the consolidated national best bid and offer quotation ("NBBO") for the security selected during the one minute random pricing window.

The IDX Regular Matches will sometimes take place at a price that is below the last reported price for that security in the consolidated transaction reporting system. Absent an exemption, short sale orders executed in IDX Regular Matches could result in violations of Rule 10a-1.

You believe that short sales executed through the IDX do not involve the types of abuses that Rule 10a-1 is designed to address. In support of this, you note that: all IDX trades are processed on an anonymous basis and prices are fixed at the midpoint of the consolidated NBBO for the security selected during the one minute random pricing window; there is no price discovery within the IDX because orders are not displayed and no participant can be assured of a match and no participant knows precisely when the match will occur. You also state that all short sale orders entered in the IDX will be appropriately marked in accordance with applicable rules. You also state that Instinet has established procedures to monitor changes to bids and offers for stocks traded in IDX matches to look for signs of manipulation. If Instinet suspects that a subscriber has engaged in a manipulative activity through the IDX, Instinet will report such activity to the appropriate SRO.

In view of the passive nature of pricing for the IDX system, you have requested that the Commission grant an exemption from Rule 10a-1 for Instinet's institutional customers, including broker-dealers, that execute short sale transactions through Instinet's Regular Matches.

Response:

Rule 3b-3 under the Exchange Act defines the term "short sale," and Rule 10a-1 governs short sales generally. Paragraph (a) of Rule 10a-1 covers transactions in any security registered on a national securities exchange, if trades in such security are reported pursuant to an "effective transaction reporting plan" ("Reported Securities"). A short sale of a Reported Security listed on a national securities exchange may not be effected at a price either: (1) below the last reported price of a transaction reported in the consolidated transaction reporting system ("minus tick"); or (2) at the last reported price if that price is lower than the last reported different price ("zero-minus tick").¹

Absent relief, trades effected in the IDX Regular Matches involving short sales of exchange-listed Reported Securities would have to comply with the "tick test" of paragraph (a) of Rule 10a-1. As described above, Regular Matches in the IDX occur at the mid-point of the NBBO, which can result in short sales being effected at prices lower than the last reported sale price. Based on your representations, in particular, that: the IDX Regular Matches will occur at an externally derived price within the existing market and above the current best bid; there is no price discovery within the IDX because orders are not displayed; no participant can be assured of receiving a match; and the matches will occur on a random basis within each window so no participant knows precisely when the match will occur, the Division is of the view that IDX trades would not appear to involve the types of abuses that Rule 10a-1 was designed to address.

Accordingly, on the basis of your representations and the facts presented, the Commission hereby grants, on a one-year pilot basis,² an exemption from Rule 10a-1 to permit short sales effected during the IDX Regular Matches, as described above, without complying with the "tick" provisions of the rule, subject to the following conditions:

1. Persons relying on this exemption shall not be represented in the primary market offer or otherwise influence the primary market bid or offer at the time of the transaction; and

2. Transactions effected through the IDX shall not be made for the purpose of creating actual, or apparent, active trading in or depressing or otherwise manipulating the price of any security.

3. The exemption applies only to: exchange-listed Reported Securities that qualify as an "actively-traded security" under Regulation M or is one of the securities that comprise the S&P 500 Index;³ and where the exchange-listed Reported Security is not an "actively-traded security" or a S&P 500 Index security, the transaction is part of a basket transaction of 20 or more securities in which the subject security does not comprise more than 5% of the value of the basket traded.

4. During each one-minute window of a Regular Match, there will be no solicitation of orders from customers, nor will there be any communication to customers that the match has not yet occurred.

5. All short sale orders shall be marked as such.

6. Instinet shall maintain and provide the Division of Market Regulation, upon request, separately retrievable written records pertaining to: each short sale transaction effected in the IDX Regular Matches, including the date, time, security, price, and size of each transaction; and the execution of each Regular Match, including the date and time of each Regular Match.

The foregoing exemption from Rule 10a-1(a) is based solely on your representations and the facts presented, and is strictly limited to the application of this rule to the proposed transactions and the operation of the IDX system as described above. Such transactions should be discontinued, pending presentation of the facts for our consideration, in the event that any material change occurs with respect to any of those facts and representations. The exemption granted herein is subject to modification or revocation if at any time the Commission or the Division determines that such action is necessary or appropriate in furtherance of the purposes of the Exchange Act.

In addition, your attention is directed to the anti-fraud and anti-manipulation provisions of the Exchange Act, particularly Sections 9(a) and 10(b), and Rule 10b-5 thereunder. Responsibility for compliance with these and any other applicable provisions of the federal securities laws must rest with Instinet and with participants effecting transactions in the IDX. This Division expresses no view with respect to any other questions that the proposed transactions may raise, including, but not limited to, the adequacy of the disclosure concerning, and the applicability of any federal or state laws to, the proposed transactions.

¹ As noted in your letter, the Commission has proposed, but not yet adopted, changes to current short sale regulation under Regulation SHO. Exchange Act Release No. 48709 (October 28, 2003), 68 FR 62972 (November 6, 2003).

² Instinet will provide, six months from the date of this exemption, written records to the Division documenting the operation of the IDX system. Prior to June 8, 2005 the Division will determine whether to extend this exemption.

³ 17 CFR 242.101(c)(1). Under Rule 101(c)(1) of Regulation M, actively-traded securities have an average daily trading volume (ADTV) value of at least $1 million and are issued by an issuer with a public float value of at least $150 million. For purposes of this letter, the ADTV shall be calculated in reference to the date on which the proposed IDX match is to take place.

Incoming Letter

Incoming letter is in PDF format.

http://www.sec.gov/divisions/marketreg/mr-noaction/instinetgroup060804.htm