[Federal Register: March 5, 2007 (Volume 72, Number 42)]
[Notices]
[Page 9810-9812]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr05mr07-91]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-55351; File No. SR-NASD-2005-146]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Notice of Filing of Amendment No. 3 to and Order
Granting Accelerated Approval of a Proposed Rule Change as Modified by
Amendment Nos. 2 and 3 Thereto To Expand the Scope of IM-2110-2
Relating To Trading Ahead of Customer Limit Orders To Apply to All OTC
Equity Securities
February 26, 2007.
I. Introduction
On December 9, 2005, the National Association of Securities
Dealers, Inc. (``NASD'') filed with the Securities and Exchange
Commission (``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to expand the scope of NASD
Interpretive Material (``IM'') 2110-2, Trading Ahead of Customer Limit
Order (``IM-2110-2'', which is commonly referred to as the ``Manning
Rule''), and any interpretive guidance thereunder, to include over-the-
counter (``OTC'') equity securities.\3\ On September 26, 2006, NASD
filed Amendment No. 1 to the proposed rule change, and on October 19,
2006, NASD filed Amendment No. 2 to the proposed rule change.\4\ The
proposed rule change, as amended, was published for comment in the
Federal Register on November 9, 2006.\5\ The Commission received one
comment letter on the proposal, which supported the proposal.\6\ On
February 6, 2007, the Exchange filed Amendment No. 3 to the proposed
rule change.\7\ This order provides notice of Amendment No. 3 to the
proposed rule change and approves the proposed rule change as modified
by Amendment Nos. 2 and 3 on an accelerated basis.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See NASD Rule 6610(d) (defining ``OTC Equity Security'').
\4\ Amendment No. 1 replaced and superseded the original filing
in its entirety and Amendment No. 2 replaced and superseded
Amendment No. 1 in its entirety.
\5\ See Securities Exchange Act Release No. 54705 (November 3,
2006), 71 FR 65863 (``Notice'').
\6\ See Letter from Shane E. Swanson, Director of Compliance,
Automated Trading Desk, LLC, to Nancy M. Morris, Secretary,
Commission, dated December 29, 2006. Although this letter was not
submitted in response to SR-NASD-2005-146, the letter referred to
the instant filing and expressed support for NASD's proposal to
require the lesser of $0.01 or \1/2\ the spread of price improvement
with respect to the implementation of Manning Rule protection to
orders priced below $1.00.
\7\ The text of Amendment No. 3 is available at NASD, the
Commission's Public Reference Room, and http://www.nasd.com.
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II. Description of the Proposal
NASD's Manning Rule generally prohibits an NASD member from trading
for its own account in an exchange-listed security at a price that is
equal to or better than an unexecuted customer limit order in that
security, unless the member immediately thereafter executes the
customer limit order at the price at which it traded for its own
account or better. The legal underpinnings for the Manning Rule are a
member's fiduciary obligations and the requirement that a member must,
in the conduct of its business, ``observe high standards of commercial
honor and just and equitable principles of trade.'' \8\ IM-2110-2
currently applies to exchange-listed securities, \9\ but does not apply
to OTC equity securities.
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\8\ See NASD Rule 2110.
\9\ See Securities Exchange Act Release No. 52210 (August 4,
2005), 70 FR 46897 (August 11, 2005) (SR-NASD-2004-089) (approving
the expansion of IM-2110-2, which previously applied only to Nasdaq
securities, to exchange-listed securities). See also NASD Notice to
Members 05-64 (October 2005) (announcing Commission approval of the
amendments to IM-2110-2, which became effective on January 2, 2006).
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NASD Rule 6541 extends the general principles of the Manning Rule
to a subset of OTC equity securities--specifically, those equity
securities that are quoted on NASD's OTC Bulletin Board (``OTCBB'').
NASD Rule 6541, however, differs from IM-2110-2 in
[[Page 9811]]
several respects.\10\ For example, while IM-2110-2 and NASD Rule 6541
both provide that a member is not deemed to have traded ahead of a
customer limit order if the member provides a contemporaneous execution
of the customer's order, the two rules differ in how they define
``contemporaneous.'' \11\ Other differences include the fact that NASD
Rule 6541 applies a lower threshold requirement on the value of large-
size limit orders for which a member can negotiate specific terms and
conditions applicable to the acceptance of such orders \12\ and IM-
2110-2 excludes marketable limit orders, whereas NASD Rule 6541
provides no such exclusion. In addition, IM-2110-2 generally is
applicable from 9:30 a.m. to 6:30 p.m. Eastern Time, whereas NASD Rule
6541 applies only from 9:30 a.m. to 4 p.m. Eastern Time. IM-2110-2 and
NASD Rule 6541 also differ in the minimum level of price-improvement
that a member must provide to trade ahead of an unexecuted customer
limit order;\13\ and NASD Rule 6541 does not require, as IM-2110-2
does, that a member that has traded ahead of a customer limit order at
a price that is more favorable than the customer limit order price pass
along that price improvement to the customer limit order.\14\
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\10\ See Notice, supra note 5 (for a detailed discussion of the
differences between NASD Rule 6541 and IM-2110-2).
\11\ For the purposes of IM-2110-2, contemporaneous has been
interpreted to require execution as soon as possible, but absent
reasonable and documented justification, within one minute. See NASD
Notices to Members 95-67 (August 1995) and 98-78 (September 1998).
In contrast, NASD Rule 6541(d) provides that the contemporaneous
execution should occur as soon as practicable, but in no event more
than five minutes after the member has traded at a price superior to
the held customer limit order. See NASD Notice to Members 01-46
(July 2001).
\12\ Specifically, NASD Rule 6541(c) only requires that an order
be 10,000 shares or more and greater than $20,000 in value, while
IM-2110-2 requires that an order be 10,000 shares or more and
greater than $100,000 in value.
\13\ Specifically, the price-improvement standard currently set
forth in IM-2110-2 provides that, where a member is holding a
customer limit order priced at or inside the inside market displayed
in Nasdaq, the member may execute an incoming order on a proprietary
basis without being obligated to execute the customer limit order if
the member executes the incoming order at least $0.01 better than
the price of the customer limit order. Further, if the customer
limit order is priced outside the inside market displayed in Nasdaq,
then the member must execute the incoming order at the next superior
minimum quotation increment permitted by Nasdaq (currently $0.01).
In contrast, NASD Rule 6541 provides that if the customer limit
order is priced at or inside the current inside market, the price
improvement is a minimum of the lesser of $0.01 or one-half (\1/2\)
of the current inside spread.
\14\ See Securities Exchange Act Release No. 52210 (August 4,
2005), 70 FR 46897 (August 11, 2005) (SR-NASD-2004-089). See also
NASD Notice to Members 05-64 (October 2005).
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In support of its proposal, NASD stated its belief that the
distinctions in application between NASD Rule 6541 and IM-2110-2 no
longer make sense, and that customer limit orders in OTC equity
securities and NMS stocks should be subject to the same order handling
and customer protection requirements under the Manning Rule.\15\
Accordingly, NASD proposes to expand the scope of IM-2110-2 and any
interpretive guidance thereunder to include all OTC equity
securities.\16\ In addition, NASD proposes to adopt new standards
relating to the minimum amount of price improvement necessary in order
for a member to execute an incoming order on a proprietary basis when
holding an unexecuted limit order in that same security and not be
required to execute the held limit order. Specifically, for customer
limit orders priced greater than or equal to $1.00 that are at or
inside the best inside market, the minimum amount of price improvement
required would be $0.01, and for customer limit orders priced less than
$1.00 that are at or inside the best inside market, the minimum amount
of price improvement required would be the lesser of $0.01 or one-half
(\1/2\) of the current inside spread. Subsequently, in light of the
proposed expansion of IM-2110-2 to cover OTC equity securities, NASD
proposes to repeal NASD Rule 6541.
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\15\ See Notice, supra note 5, at 71 FR 65865.
\16\ NASD states that the term ``OTC equity securities'' does
not include options. See NASD Rule 6610(d) (defining OTC equity
security as any non-exchange-listed security and certain exchange-
listed securities that do not otherwise qualify for real-time trade
reporting).
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NASD also proposes to delete the obsolete provisions in IM-2110-2
that prescribe the minimum level of price-improvement for securities
trading in non-decimalized fractions since equity securities no longer
trade in fractions. In addition, NASD proposes to delete obsolete
references in IM-2110-2, which limit portions of the Manning Rule's
applicability to Nasdaq-listed securities. Finally, given that the
definition of ``NMS stock'' in Rule 600(b)(47) of Regulation NMS \17\
substantially covers all stocks listed on a national securities
exchange, the proposal would replace references to the term ``exchange-
listed security'' in IM-2110-2 with the term ``NMS stock.''
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\17\ 17 CFR 242.600(b)(47).
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The proposal would be subject to delayed effectiveness. In
particular, as proposed in the Notice, NASD would announce the
effective date of the proposed rule change in a Notice to Members to be
published no later than 60 days following Commission approval of this
proposal. In recognition of the technological and systems changes the
proposed rule change may require, NASD has noted that it will set the
effective date of the amendments contained in this proposed rule change
at 90 days following publication of the Notice to Members announcing
Commission approval of this filing.
III. Discussion and Commission Findings
The Commission has reviewed carefully the proposed rule change and
the comment letter and finds that the proposed rule change is
consistent with the Act and the rules and regulations thereunder
applicable to a national securities association, including the
provisions of Section 15A(b)(6) of the Act,\18\ which requires, among
other things, that NASD rules be designed to promote just and equitable
principles of trade, to foster cooperation and coordination with
persons engaged in regulating, clearing, settling, processing
transactions in securities, and, in general, to protect investors and
the public interest.\19\
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\18\ 15 U.S.C. 78o-3(b)(6).
\19\ In approving this proposed rule change, as amended, the
Commission notes that it has considered the proposed rule's impact
on efficiency, competition, and capital formation. See 15 U.S.C.
78c(f).
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Currently, IM-2110-2 prohibits an NASD member from trading for its
own account in an exchange-listed security at a price that is equal to
or better than an unexecuted customer limit order in that security,
unless the member immediately thereafter executes the customer limit
order at the price at which it traded for its own account or better.
NASD Rule 6541 extends the general principles of IM-2110-2 to those OTC
equity securities that are quoted on the OTCBB. As discussed above,
NASD Rule 6541, however, differs from IM-2110-2 in several respects,
including the applicable trading hours, time limits for
``contemporaneous'' executions, and the threshold for individually-
negotiable large-size orders. NASD's proposal would revise IM-2110-2 to
include OTC equity securities. The Commission believes that NASD's
proposal to apply the Manning Rule's limit order protection
requirements uniformly to NMS stocks and OTC equity securities is
appropriate and should benefit customers who submit limit orders for
OTC equity securities.
NASD also proposes to amend the provisions relating to the amount
of price-improvement necessary in order
[[Page 9812]]
for a member to execute an incoming order on a proprietary basis when
holding an unexecuted customer limit order in that same security. The
proposal would revise and make uniform the minimum price-improvement
standards for all NMS stocks and OTC equity securities.\20\ With
respect to the minimum level of price-improvement that a member must
provide in order to trade ahead of an unexecuted customer limit
order,\21\ NASD proposes that, for customer limit orders priced greater
than or equal to $1.00 that are at or inside the inside market, the
minimum amount of price improvement required would be $0.01. For
customer limit orders priced less than $1.00 that are at or inside the
inside market, the minimum amount of price improvement required would
be the lesser of $0.01 or one-half (\1/2\) of the current inside
spread. For customer limit orders priced outside the inside market, the
member would be required to execute the incoming order at a price at or
inside the inside market for the security. Lastly, for customer limit
orders in securities for which there is no published inside market, the
minimum amount of price improvement required is $0.01. The Commission
believes that the proposed uniform price improvement standards are
appropriate and reasonably designed to protect customer limit orders in
both NMS stocks and OTC equity securities. The Commission also believes
that the proposal is reasonably designed to remove obsolete references
to price improvement standards in non-decimalized fractions, as well as
references to portions of the Manning Rule that were formerly
applicable only to securities quoted on Nasdaq.
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\20\ NASD also proposes to delete the provisions in IM-2110-2
that prescribe the minimum level of price-improvement for securities
trading in non-decimalized fractions since equity securities no
longer trade in fractions. In addition, NASD proposes to delete
references in IM-2110-2, which limit portions of the Manning Rule's
applicability to Nasdaq-listed securities.
\21\ The Manning Rule provides that a member is not deemed to
have traded ahead of a customer limit order if the member provides a
contemporaneous execution of the customer's order.
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For the reasons described above, the Commission believes that
NASD's proposed rule change promotes the protection of investors and
the public interest by expanding the scope of IM-2110-2 to apply to NMS
stocks and OTC equity securities. Further, in expanding the application
of Manning obligations under IM-2110-2 to include OTC equity securities
and establishing uniform standards for both NMS stocks and OTC equity
securities, the Commission believes that the proposal will enhance the
opportunity for investors to receive superior-priced limit order
executions in OTC equity securities.
NASD has requested that the Commission find good cause for
approving the proposed rule change prior to the thirtieth day after the
date of publication of notice of Amendment No. 3 in the Federal
Register. In Amendment No. 3, NASD requested that the Commission grant
permanent approval of the price-improvement standards for decimalized
securities contained in IM-2110-2 that currently apply on a pilot
basis.\22\ The Commission notes that the proposal, as modified by
Amendment No. 2, was published for notice and comment,\23\ and that the
Commission received one comment letter in support of the proposal.\24\
Amendment No. 3 simply seeks to clarify the status of the provision of
IM-2110-2 concerning price improvement standards for decimalized
securities, which is proposed to be amended as part of the instant
proposed rule change. The Commission believes that permanent approval
of the pilot is appropriate because the minimum price improvement
standards, including the revisions contained in the instant proposed
rule change, are reasonably designed to protect customer limit orders
in both NMS stocks and OTC equity securities. In addition, the
Commission does not believe that Amendment No. 3 raises any new or
novel issues. Based on the above, the Commission finds good cause to
accelerate approval of the proposed rule change, as modified by
Amendment Nos. 2 and 3.
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\22\ See Securities Exchange Act Release No. 44165 (April 6,
2001), 66 FR 19268 (April 13, 2001) (SR-NASD-2001-27). See also
Securities Exchange Act Release No. 54953 (December 18, 2006), 71 FR
77429 (December 26, 2006) (SR-NASD-2006-134) (extending the pilot
until June 30, 2007).
\23\ See Notice, supra note 5.
\24\ See supra note 6 (citing to the comment letter).
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or Send an e-mail to rule-comments@sec.gov. Please include
File Number SR-NASD-2005-146 on the subject line.
Paper Comments
Send paper comments in triplicate to Nancy M. Morris,
Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-NASD-2005-146. This file
number should be included on the subject line if e-mail is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for inspection and
copying in the Commission's Public Reference Room. Copies of the filing
also will be available for inspection and copying at the principal
office of NASD. All comments received will be posted without change;
the Commission does not edit personal identifying information from
submissions. You should submit only information that you wish to make
available publicly. All submissions should refer to File Number SR-
NASD-2005-146 and should be submitted on or before March 26, 2007.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\25\ that the proposed rule change (SR-NASD-2005-146), as modified
by Amendment Nos. 2 and 3, be, and hereby is, approved on an
accelerated basis.
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\25\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\26\
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\26\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-3748 Filed 3-2-07; 8:45 am]
BILLING CODE 8010-01-P