[Federal Register: December 24, 2002 (Volume 67, Number 247)]
[Notices]
[Page 78537-78540]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr24de02-141]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-47003; File No. SR-NASD-2002-59]
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change by the National Association of Securities Dealers, Inc. Relating
to a New Trade Report Modifier To Be Attached to Trades Whose Prices
Exceed Certain Parameters
December 16, 2002.
I. Introduction
On April 29, 2002, the National Association of Securities Dealers,
Inc. (``NASD''), through its subsidiary, the Nasdaq Stock Market, Inc.
(``Nasdaq''), 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 create a new trade report modifier to be
attached to trades whose prices exceed certain parameters. The proposed
rule change was published for comment in the Federal Register on June
14, 2002.\3\ The Commission received two comment letters regarding the
proposal.\4\ Nasdaq responded to the commenters on November 30,
2002.\5\
[[Page 78538]]
This order approves the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 46056 (June 10,
2002), 67 FR 40975.
\4\ See letter from Michael T. Dorsey, Senior Vice President,
Director of Legislative and Regulatory Affairs, Knight Trading
Group, to Commission, dated July 19, 2002 (``Knight Letter'') and
letter from Cindy D. Foster, Vice President, Compliance, SunGard
Trading Systems, to Jonathan G. Katz, Secretary, Commission, dated
July 5, 2002 (``SunGard Letter'').
\5\ See letter from Edward S. Knight, Executive Vice President,
General Counsel, Nasdaq, to Jonathan G. Katz, Secretary, Commission,
dated November 20, 2002 (responding to the comment letters received
regarding the proposed rule change) (``Nasdaq Response Letter'').
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II. Background
Trades reported to Nasdaq using the Automated Confirmation
Transaction (``ACT'') Service are subject to procedures that identify
trades executed at prices away from the current market. This process
helps to ensure a fair and orderly market by preventing such trades
from being disseminated to the public as last sale reports and/or by
detecting trades that are reported at erroneous prices.
The process differs slightly depending on whether a trade is
executed using a Nasdaq system, which then automatically reports the
trade to ACT (e.g., SelectNet), or the trade is submitted to ACT
directly by a member. ACT rejects a trade that is submitted directly by
a member if the price reported is outside established parameters. The
member has an opportunity to resubmit the trade, which then will be
subject to a different set of parameters. If the price is rejected
after this second process, the member must call Nasdaq's MarketWatch
Department to explain why the execution price was so far away from the
current market. If the MarketWatch staff determines, on the basis of
its conversation with the member, that there is an adequate rationale
for such price, the staff would submit the trade to ACT.\6\ In such
circumstances, the trade is normally being reported more than 90
seconds after the trade was executed, and so the MarketWatch staff
would report the trade with the .SLD modifier attached, which indicates
a late trade report.\7\ Trades reported with a .SLD modifier are not
included in the last sale calculation, but are included in the
calculation of the high and low price for the security.
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\6\ If the MarketWatch staff believes the price would be
misleading to the market, the trade report would be submitted for
clearing purposes only. Nasdaq believes that the number of instances
in which the staff submits the report only for clearing purposes is
very limited. The staff estimates that this occurs less than 10
times a year. In addition, the staff can refer the transaction to
NASD Regulation for further investigation.
\7\ NASD rules require that trades be marked late, using the
.SLD modifier, if they are reported more than 90 seconds after
execution. See e.g., NASD Rule 4632.
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Trades executed using Nasdaq systems, however, are subject to a
different process due to the manner in which such trades are
transmitted to ACT. The information passed to ACT from a Nasdaq system
does not include the exact location, or terminal, within a member from
which an order/execution emanates. Therefore, such trades are not
subject to the second validation process which allows members to
resubmit a trade report after it is rejected initially, since the exact
location within a member to which a reject message can be sent is
unknown. To compensate for this difference and to prevent such trades
from being included in the last sale calculation, Nasdaq automatically
attaches the .SLD modifier to any trades executed using a Nasdaq system
whose prices exceed the initial parameters. Nasdaq also includes
another modifier with these trade reports to indicate that the .SLD
modifier has been attached by a Nasdaq system. This other modifier
ensures that members would not be cited for late trade reporting on the
basis of these trades.
Nasdaq believes that the process described above has worked well in
promoting a fair and orderly market because it has prevented certain
anomalous prices from being included in the last sale calculation,
which is used for many purposes including as a measure of the current
market for a security; a determinant of the execution price of certain
types of orders (e.g., market on close orders); and in determining
index values. Nasdaq believes this process has helped provide more
accurate information about the prices at which individual securities
are trading, and for that matter, the market, or a segment of the
market, if such securities are components of indices designed to
measure the entire market or a particular segment.
III. Description of the Proposed Rule Change
Under the proposed rule change, Nasdaq has identified a means of
further improving the current process. Presently, the .SLD modifier
prevents a trade report from being included in the last sale
calculation, but it does not prevent such a report from being included
in the calculation of the high and low price of a security. As such, a
trade that has been excluded from the last sale calculation because its
price exceeds the parameters, nevertheless, may set the high or low
price for a security. Nasdaq believes that these trades should not
establish the high or low price for a security because the high and low
prices are also used as a measure of a security's performance, or could
trigger certain actions.
Therefore, Nasdaq proposed to create a new modifier that would
exclude such trades from the high/low calculations, as well as the last
sale calculation.\8\ This new modifier tentatively would be known as
the ``Out of Range,'' or .OR , modifier and would be used instead of
the .SLD modifier in the circumstances described above. Under the
proposed rule change, members would not have the ability to append this
modifier to trade reports. Nasdaq proposed that only Nasdaq staff and
Nasdaq systems would append this modifier, and only for transactions in
Nasdaq National Market System, SmallCap Market, and OTC Bulletin Board
securities. For example, if a trade executed using SelectNet exceeds
the price parameters, ACT automatically would append the .OR modifier
to the trade report instead of the .SLD modifier. Similarly, the Nasdaq
MarketWatch staff would append the .OR modifier to reports they submit.
Nasdaq believes that the number of trade reports that contain the .SLD
modifier either attached by ACT or the Nasdaq MarketWatch staff because
the price is outside the parameters is very small.\9\ Nasdaq believes
that the current proposal to create a new modifier would not affect
this number since all that is being changed is the modifier that is
being attached, and Nasdaq is not proposing to modify the price
parameters.
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\8\ Nasdaq recognizes that trades whose prices exceed the price
parameters nevertheless may be valid transactions that the parties
want to settle. As such, these trades are transmitted to The
Depository Trust and Clearing Corporation for clearing and
settlement.
\9\ Nasdaq estimates that, on a daily average, less than .002%
of trades executed on Nasdaq are reported with the .SLD modifier due
to the trade being executed at a price that exceeds the price
parameters.
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Nasdaq recognized that, in certain circumstances, members may
believe that they have executed a trade at a price that provides
valuable information to the market, even though the price is outside
the parameters. To ensure that such trades are not inappropriately
withheld from the last sale and high/low calculations, members would be
able to contact the Nasdaq MarketWatch staff to request that the .OR
modifier be removed from the trade report. The member must explain the
facts and circumstances surrounding the trade and why the price was
reasonable, as measured against the market at the time of execution. If
the MarketWatch staff agrees with the explanation, it can remove the
.OR modifier from the trade report.
The process for developing and implementing the modifier, which
will include testing with market data vendors, will take several
months. Nasdaq would continue to utilize the .SLD modifier in the
manner described until the new modifier can be implemented.
[[Page 78539]]
IV. Summary of Comments and Nasdaq's Response
As noted above, the Commission received two comment letters
regarding the proposal.\10\ Nasdaq filed a response letter to address
concerns raised by the commenters.\11\
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\10\ See Knight Letter and SunGard Letter, supra note 4.
\11\ See Nasdaq Response Letter, supra note 5.
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One commenter commended Nasdaq for its proposal as promoting a fair
and orderly market for Nasdaq stocks through improved transparency.\12\
This commenter supported the new modifier as a better indication of the
trading activity then occurring in the marketplace. This commenter also
suggested that Nasdaq create additional modifiers to address other
unique execution scenarios, such as ``market on close'' orders. Nasdaq
has indicated that it is presently examining several additional
modifiers to address some of this commenter's concerns.\13\
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\12\ See Knight Letter, supra note 4.
\13\ See Nasdaq Response Letter, supra note 5.
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The other commenter supported Nasdaq's proposal, but believed that
the proposal should not be approved absent providing the same relief to
members effecting transactions and transaction reports outside Nasdaq
systems who experience similar problems with rejected trades.\14\ This
commenter believed that the process of having a member telephone Nasdaq
MarketWatch, after ACT has rejected a trade for the second time, in
order to enter the transaction and then append the .SLD, delays a
trader's operations and could harm the execution of pending customer
orders, especially in today's highly automated marketplace.
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\14\ See SunGard Letter, supra note 4.
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This commenter offered two methods that it believed would result in
better use of member, market, and regulatory resources and further
prevent any degrading of the execution of customer orders. First, the
commenter suggested that Nasdaq adopt a new modifier that would be
appended to transaction reports that followed the second rejection of
ACT. Under this method, Nasdaq and NASD surveillance could then monitor
the proper use of such modifier and, on a post-report review process
during the day, contact members about those transactions that appear
problematic. Alternatively, this commenter suggested that Nasdaq
systems be programmed to automatically append a .SLD modifier and a .OR
as it would with transactions executed and reported by Nasdaq systems.
Transaction reports which evidence a delay between the execution and
transaction report or a delay of the re-submission could still be
rejected, and Nasdaq could then review these transactions on post-
review basis.
In response, Nasdaq stated that its proposal complies with Section
15A(b)(6) of the Act \15\ to protect investors and the public interest
because it would result in the public dissemination of information that
reflects more accurately the current trading in a particular
security.\16\ Furthermore, to the extent a security is a component of
an index, the index would reflect more accurately the value of the
market, or segment of market the index is designed to measure. Nasdaq
also stated that this commenter offered no statutory analysis that
would contradict Nasdaq's compliance with the Act and support the
commenter's request to delay approval of the proposed rule change.
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\15\ 15 U.S.C. 78o-3(b)(6).
\16\ See Nasdaq Response Letter, supra notes.
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Furthermore, with respect to the commenter's suggestions, Nasdaq
does not believe that it would be feasible to permit members to use the
.OR modifier. Under the proposal, trades reported with a .OR modifier
would not be included in the calculation of last sale, high price and
low price of the security. Nasdaq notes that these calculations provide
investors and market participants with important information about the
prices at which a security is trading, and generally promote
transparency and accurate price discovery. Therefore, Nasdaq believes
that this ability to append the .OR modifier and thus prevent it from
being included in these calculations must be strictly controlled. If
members were permitted to append the .OR modifier, Nasdaq notes that
the potential for mistake or purposely misusing the .OR modifier to
withhold certain trade prices would have to be considered. Moreover,
there is presently no automated, real-time means to surveil members for
the proper use of the .OR modifier. Nasdaq believes this surveillance
would be necessary to ensure that mistakenly marked trades are
identified and then publicly disseminated at, or near, the time of the
trade, which is when the information is useful. This risk of error,
misuse, and surveillance complications also would limit the usefulness
of any other modifier Nasdaq would create for use by members that would
operate in the same manner as the .OR modifier.
Finally, Nasdaq states that it recognizes the challenges faced by
members reporting trades in a fast-moving market and would continue to
examine how it can address some of the concerns raised by this
commenter. However, Nasdaq believes that the proposed solution should
not create additional surveillance burdens for members and Nasdaq that
outweigh the benefits of the proposal, or worse, that the benefits are
exceeded by the potential for new areas of abuse. Nasdaq believes that
developing a solution that strikes a balance among these factors is a
lengthy process, and that delaying approval of its current proposal
until a broader solution can be implemented would unnecessarily delay
the benefits the .OR modifier currently can provide to investors and
market participants.
V. Discussion
After careful review, 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.\17\ In particular, the Commission finds that the proposal
is consistent with Section 15A(b)(6) of the Act,\18\ in that it is
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, to foster cooperation
and coordination with persons engaged in 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.
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\17\ In approving this proposal, the Commission has considered
the proposed rule's impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
\18\ 15 U.S.C. 78o-3(b)(6).
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Specifically, the Commission finds that Nasdaq's proposal appears
to be a reasonable effort to improve the information disseminated to
investors. The Commission believes that the proposed modifier may be a
practical method in identifying with specificity trades that fail price
validation and may prevent these trades from impacting the last sale
calculation and the high and low price for the security. The Commission
also believes that the corresponding result of the proposal may be
trades, or other actions, executed at prices more reflective of the
current market when the price of an execution, or other action, is
based on the last sale, the high price or low price of a security, or
the value of an index. Furthermore, the Commission believes that the
proposal and Nasdaq's Response Letter appears to reasonably address the
concerns raised by the commenters. Nasdaq has noted that it
[[Page 78540]]
would continue examining several additional modifiers and solutions to
address other unique scenarios, such as ``market on close'' orders, and
issues raised by the commenters.\19\
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\19\ See Nasdaq Response Letter, supra notes.
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VI. Conclusion
For the foregoing reasons, the Commission finds that the proposed
rule change is consistent with the requirements of the Act and rules
and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\20\ that the proposed rule change (SR-NASD-2002-59) is approved.
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\20\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\21\
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\21\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-32316 Filed 12-23-02; 8:45 am]
BILLING CODE 8010-01-P