[Federal Register: October 31, 2006 (Volume 71, Number 210)]
[Notices]
[Page 63812-63814]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr31oc06-97]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-54650; File No. SR-NASD-2004-130]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Notice of Filing of Proposed Rule Change and Amendment
Nos. 1 and 2 Relating to Amendments to Rule 2320(g) (Three Quote Rule)
and Corresponding Recordkeeping Requirements Under Rule 3110(b)
October 25, 2006.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on August 27, 2004, the National Association of Securities Dealers,
Inc. (``NASD'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission'') the proposed rule change as described in
Items I, II, and III below, which Items have been prepared by NASD. On
May 8, 2006, NASD filed Amendment No. 1 to the proposed rule change.\3\
On October 19, 2006, NASD filed Amendment No. 2 to the proposed rule
change.\4\ The Commission is publishing this notice to solicit comments
on the proposed rule change, as amended, from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Amendment No. 1 replaced and superceded in its entirety the
text of the original filing.
\4\ Amendment No. 2 replaced and superceded in its entirety the
text of the original filing, as amended.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
NASD is proposing to amend Rule 2320(g) (``Three Quote Rule'') and
the corresponding recordkeeping requirements under Rule 3110(b) to
exclude from the Three Quote Rule's coverage transactions in foreign
securities of a foreign issuer that are part of the FTSE All-World
Index.
Below is the text of the proposed rule change. Proposed new
language is in italics; proposed deletions are in brackets.
* * * * *
2320. Best Execution and Interpositioning
(a) through (f) No Change.
(g) (1) Except as provided in subparagraph (3) below, [Unless two
or more priced quotations for a non-exchange-listed security (as
defined in the Rule 6600 Series) are displayed in an inter-dealer
quotation system that permits quotation updates on a real-time basis,]
in any transaction for or with a customer pertaining to the execution
of an order in a non-exchange-listed security (as defined in the Rule
6600 Series), a member or person associated with a member shall contact
and obtain quotations from three dealers (or all dealers if three or
less) to determine the best inter-dealer market for the subject
security.
(2) No Change.
(3) The requirements described in subparagraph (1) above shall not
apply:
(A) when two or more priced quotations for a non-exchange-listed
security are displayed in an inter-dealer quotation system that permits
quotation updates on a real-time basis; or
(B) to any transaction pertaining to the execution of an order in a
non-exchange-listed security of a foreign issuer that is part of the
FTSE All-World Index if such transaction is executed during the regular
business hours of the foreign market for the foreign security and no
trading halt or other similar trading or quoting restriction is in
effect in any foreign market on which such foreign security is listed.
(4) Definitions.
For purposes of this paragraph (g): [,]
(A) T[t]he term ``inter-dealer quotation system'' means any system
of general circulation to brokers or dealers that regularly
disseminates quotations of identified brokers or dealers.
(B) [(4) For purposes of this paragraph,] T[t]he term ``quotation
medium'' means any inter-dealer quotation system or any publication or
electronic communications network or other device that is used by
brokers or dealers to make known to others their interest in
transactions in any security, including offers to buy or sell at a
stated price or otherwise, or invitations of offers to buy or sell.
(5) No Change.
* * * * *
3110. Books and Records
(a) No Change.
(b) Marking of Customer Order Tickets
A person associated with a member shall indicate on the memorandum
for each transaction in a non-exchange-listed security, as that term is
defined in the Rule 6600 Series, the name of each dealer contacted and
the quotations received to determine the best inter-dealer market;
however, the requirements of this subparagraph shall not apply if the
member can establish and has documented that:
(1) two or more priced quotations for the security are displayed in
an inter-dealer quotation system, as defined in Rule 2320(g), that
permits quotation updates on a real-time basis for which NASD
[Regulation] has access to historical quotation information; or
(2) the transaction is effected in compliance with Rule
2320(g)(3)(B).
(c) through (j) No Change.
* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, NASD included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. NASD has prepared summaries, set forth in Sections A, B,
and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
Rule Filing History
On August 27, 2004, NASD filed with the Commission proposed rule
change SR-NASD-2004-130, proposing amendments to Rule 2320(g) and Rule
3110(b) to exclude from the Three Quote Rule's coverage transactions in
foreign securities of a foreign issuer that are part of the FTSE World
Index. On May 8, 2006, NASD filed Amendment No. 1 to change the
proposed exclusion from the Three Quote Rule's coverage transactions in
foreign securities of a foreign issuer that are part of the FTSE All-
World Index, rather than the FTSE World Index.\5\
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\5\ The FTSE World Index is a sub-set of the FTSE All-World
Index. The list of securities that comprise the FTSE All-World Index
are substantially similar to the list of securities that comprise
the FTSE World Index. The key difference is that the FTSE All-World
Index is comprised of securities from Developed, Advanced Emerging
and Secondary Emerging markets, whereas the FTSE World Index is
comprised of securities from Developed and Advanced Emerging market
segments only. The FTSE World Index, however, is no longer offered
other than to existing FTSE subscribers. Given that the FTSE World
Index would not be widely accessible, NASD amended its filing
accordingly. See Exhibit 2 to Amendment No. 2 for additional
details, available on the NASD's Web site at http://www.nasd.com.
The information in this proposed rule change, as amended, and in
Exhibit 2 thereto relating to the FTSE All-World Index is based on
information published on FTSE's Web site at http://www.ftse.com, as well as
from conversations between NASD staff and FTSE staff.
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On June 30, 2006, the Commission approved SR-NASD-2005-087, which
[[Page 63813]]
amended certain NASD rules to reflect the separation of Nasdaq from
NASD upon the operation of the Nasdaq Exchange as a national securities
exchange.\6\ Among other amendments, SR-NASD-2005-087 amended Rules
2320(g) and 3110(b) to replace the term ``non-Nasdaq securities'' with
``non-exchange-listed securities.'' SR-NASD-2005-087 became effective
on August 1, 2006, the date upon which Nasdaq began operation as an
exchange for Nasdaq-listed securities.
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\6\ See Securities Exchange Act Release No. 54084 (June 30,
2006), 71 FR 38935 (July 10, 2006).
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Given the Commission's approval of SR-NASD-2005-087, NASD filed
Amendment No. 2. Amendment No. 2, which replaces and supersedes the
prior filings in their entirety, amends the proposed rule text and
description to reflect Nasdaq's operation as an exchange, among other
clarifying changes.
Proposal
The Three Quote Rule originally was adopted on May 2, 1988,\7\ as
an amendment to NASD's best execution interpretation and generally
requires that members that execute transactions in non-exchange-listed
securities \8\ on behalf of customers contact a minimum of three
dealers (or all dealers if three or less) and obtain quotations, if
there are fewer than two quotations displayed on an inter-dealer
quotation system that permits quotation updates on a real-time basis.
The Three Quote Rule further defined a member's best execution
obligation to customers by setting forth additional requirements for
transactions in non-exchange-listed securities, particularly
transactions involving relatively illiquid securities with non-
transparent prices. The Three Quote Rule is a minimum standard, and
compliance with the rule, in and of itself, does not mean a member has
met its best execution obligations.
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\7\ See Securities Exchange Act Release No. 25637 (May 2, 1988),
53 FR 16488 (May 9, 1988).
\8\ The Three Quote Rule applies to transactions in all non-
exchange-listed securities. A non-exchange-listed security is
defined in NASD Rule 6610 as ``any equity security that is not
traded on any national securities exchange * * *.'' Therefore, the
rule by its terms applies to transactions effected on any foreign
exchange. The term ``national securities exchange'' is not defined
in NASD rules, but the requirements to qualify are set forth in
Sections 6(a) and 19(a) of the Act. See 15 U.S.C. 78f(a) and 78s(a).
See also Securities Exchange Act Release No. 39266 (October 22,
1997), 62 FR 56217 (October 29, 1997).
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Since the adoption of the Three Quote Rule, the market for non-
exchange-listed securities has changed significantly. NASD has found
that under certain circumstances, the Three Quote Rule often can
hinder, rather than further, best execution by causing significant
delays in obtaining executions of customer orders. For example, in
2000, NASD amended the Three Quote Rule to eliminate the requirement to
contact three market makers when there are at least two priced
quotations displayed in an inter-dealer quotation system that permits
quotation updates on a real-time basis.\9\ NASD concluded that, where
there were two transparent, firm quotes, the costs associated with
delayed executions resulting from compliance with the Three Quote Rule
were not outweighed by the benefits of obtaining three telephone
quotes.
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\9\ See Securities Exchange Act Release No. 43319 (September 21,
2000), 65 FR 58589 (September 29, 2000). This rule change also
alleviated the corresponding recordkeeping requirements under Rule
3110(b) where NASD could validate and confirm compliance with
applicable requirements directly through its internal historical
data.
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Similar concerns have been raised with respect to the Three Quote
Rule's application in the area of orders in foreign securities of
foreign issuers. Certain members and other interested parties had
raised concerns that the Three Quote Rule was unnecessary and
potentially harmful to the customer's best interests when a member,
using reasonable diligence, has determined that the best market for a
foreign security is a foreign market where the securities trade with
sufficient liquidity and transparency.
NASD staff agreed that the protections of the Three Quote Rule may
not be necessary with respect to all orders in foreign securities. In
fact, according to the NASD, the Commission, in its approval order
granting NASD exemptive authority with respect to the Three Quote Rule,
specifically indicated that exemptive relief may be appropriate for
transactions executed on a foreign exchange.\10\ The NASD noted that
the Commission stated that exemptive relief may be appropriate in such
circumstances because the foreign exchange may constitute the best
market for securities that are listed on that market and the time delay
involved in contacting three dealers may, therefore, hinder a member
from obtaining best execution for the customers.\11\
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\10\ See Securities Exchange Act Release No. 39266 (October 22,
1997), 62 FR 5617 (October 29, 1997).
\11\ Id.
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Accordingly, NASD is proposing amendments that would exclude from
the Three Quote Rule's coverage transactions effected in foreign
securities of foreign issuers that are part of the FTSE All-World
Index.\12\ Therefore, under the proposed rule change, a member would
not be required to obtain three quotes in connection with transactions
in foreign securities that are part of the FTSE All-World Index. The
proposed rule change would not require that the transaction be executed
on a foreign market so as not to limit the member's ability to
determine, in fulfilling its best execution obligations, that a better
execution would be obtained off the foreign market. However, to qualify
for the exemption, the transaction must be executed during regular
business hours of the foreign market for the security and no trading
halt or other similar trading or quotation restriction may be in effect
in any foreign market on which for such foreign security is listed.\13\
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\12\ NASD states that the Financial Times and the London Stock
Exchange operate the FTSE All-World Index. The FTSE All-World Index
includes 48 different countries and approximately 3,000 stocks. See
Exhibit 2 to Amendment No. 2 for a detailed description of the
criteria used to determine the FTSE All-World Index.
\13\ Contingent upon approval of the proposed rule change, NASD
staff plans to withdraw all existing exemptions it has granted to
the Three Quote Rule that relate to foreign securities. NASD staff
has granted seven exemptions for customer transactions in Canadian
securities executed on a Canadian exchange on an agency or riskless
principal basis. See, e.g., Letter to Mr. Kenneth W. Perlman,
General Counsel, Mayer & Schweitzer, Inc., from Alden S. Adkins,
Senior Vice President and General Counsel, NASD Regulation, Inc., on
May 29, 1998.
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NASD has selected the FTSE All-World Index in part because,
according to the NASD, Commission staff has deemed the foreign
securities that are listed on the FTSE World Index, a subset of the
FTSE All-World Index, as having a ``ready market'' and therefore
eligible to receive comparable favorable treatment to U.S. equity
securities under the securities haircut \14\ provisions of the SEC's
net capital rule.\15\ In addition, the Federal Reserve Board recognizes
the FTSE World Index for determining whether stocks are eligible for
margin treatment. NASD believes that the criteria used in determining
the composition of the FTSE World Index, which are substantially the
same for the FTSE All-World Index, helps to ensure that the securities
trade with a high
[[Page 63814]]
degree of liquidity, consistency, and price transparency.\16\
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\14\ NASD notes that the Commission's net capital rule requires
broker-dealers, when computing net capital, to deduct from their net
worth certain percentages of the market value of their proprietary
securities positions, commonly referred to as ``haircuts.'' Haircuts
are calculated under paragraphs (c)(2)(vi), (c)(2)(vii), and
applicable appendices of the standard net capital rule, SEC Rule
15c3-1. 17 CFR 240.15c3-1.
\15\ See 1993 SEC No-Act LEXIS 967 (August 13, 1993) (regarding
foreign equity issues listed on the FT-Actuaries World Index as
having a ready market with respect to the ready market and haircut
provisions of the SEC's net capital rule). NASD states that the
calculation of the FT/S&P Actuaries World Index was taken over by
FTSE in November 1999 and renamed the FTSE World Index, which is a
subset of the FTSE All-World Index.
\16\ The FTSE All-World Index is based on a set of rules that
govern the construction and maintenance of the index. Stocks
comprising the FTSE All-World Index are screened to, among other
things, ensure there is sufficient liquidity and the availability of
accurate and timely data. Factors in determining liquidity include
the level of trading volume relative to shares outstanding. See
Exhibit 2 to Amendment No. 2 for further information.
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Importantly, while the proposed rule change would not require a
member to obtain three quotes in connection with transactions in
foreign securities that are part of the FTSE All-World Index, members
would continue to be required to comply with their best execution
obligations under Rule 2320, and to the extent applicable, their
suitability obligations under Rule 2310.
The proposed rule change also would provide a corresponding
exclusion to the recordkeeping requirements set forth in Rule 3110(b)
relating to the Three Quote Rule if the member can establish and
document its reliance on this exclusion. Rule 3110(b) requires that
members indicate on the order ticket for each transaction in a non-
exchange-listed security the name of each dealer contacted and the
quotations received to determine the best inter-dealer market as
required by the Three Quote Rule.
In addition, NASD no longer refers to its subsidiary, NASD
Regulation, Inc., using its full corporate name, ``NASD Regulation'' or
``NASD Regulation, Inc.'' Instead, NASD uses ``NASD'' unless otherwise
appropriate for corporate or regulatory reasons. Accordingly, the
proposed rule change replaces one reference to ``NASD Regulation'' in
the text of the proposed rule change with ``NASD.''
Finally, NASD will 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. The effective date will be 30 days
following publication of the Notice to Members announcing Commission
approval.
2. Statutory Basis
NASD believes that the proposed rule change, as amended, is
consistent with the provisions of Section 15A of the Act \17\ in
general, and with Section 15A(b)(6) of the Act \18\ in particular, in
that it is 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. NASD believes
that the proposed rule change will reduce the time and effort necessary
in contacting three dealers in orders for foreign securities of certain
foreign issuers where it has been demonstrated that such securities are
trading with sufficient liquidity and price transparency.
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\17\ 15 U.S.C. 78o-3.
\18\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition
NASD does not believe that the proposed rule change will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Written comments were neither solicited nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change, as amended, 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-2004-130 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-2004-130. 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 such
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-2004-130 and should be submitted on or before November 21,
2006.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\19\
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\19\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
[FR Doc. E6-18250 Filed 10-30-06; 8:45 am]
BILLING CODE 8011-01-P