[Federal Register Volume 73, Number 184 (Monday, September 22, 2008)]
[Notices]
[Pages 54649-54652]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-22011]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-58532; File No. SR-NASD-2007-041]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc. (f/k/a National Association of Securities Dealers,
Inc.); Order Approving Proposed Rule Change, as Modified by Amendment
No. 2, To Amend the Minimum Price-Improvement Standards Set Forth in
NASD Interpretive Material (``IM'') 2110-2
September 12, 2008.
I. Introduction
On June 27, 2007, the National Association of Securities Dealers,
Inc. (``NASD'') (n/k/a Financial Industry Regulatory Authority, Inc.
(``FINRA'')) \1\
[[Page 54650]]
filed with the Securities and Exchange Commission (``Commission''),
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\2\ and Rule 19b-4 thereunder,\3\ a proposed rule change to
amend the minimum price-improvement standards set forth in NASD
Interpretive Material (``IM'') 2110-2. The proposed rule change was
published for comment in the Federal Register.\4\ The Commission
received one commenter letter on the original proposal,\5\ to which
FINRA responded in a letter to the Commission, dated November 1,
2007.\6\
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\1\ On July 26, 2007, the Commission approved a proposed rule
change filed by the NASD to amend the NASD's Certificate of
Incorporation to reflect its name change to Financial Industry
Regulatory Authority, Inc., or FINRA, in connection with the
consolidation of the member firm regulatory functions of NASD and
NYSE Regulation, Inc. See Securities Exchange Act Release No. 56146
(July 26, 2007), 72 FR 42190 (August 1, 2007) (SR-NASD-2007-053).
\2\ 15 U.S.C. 78s(b)(1).
\3\ 17 CFR 240.19b-4.
\4\ See Securities Exchange Act Release No. 56297 (August 21,
2007), 72 FR 49337 (August 28, 2007) (notice of filing of SR-NASD-
2007-041) (``Release No. 34-56297'').
\5\ See Letter to Secretary, Commission, from Jess Haberman,
Compliance Director, Fidessa Corp., dated September 5, 2007
(``Fidessa Corp. Letter'').
\6\ See Letter from Andrea Orr, FINRA, to Nancy M. Morris,
Secretary, Commission, dated November 1, 2007 (``FINRA Response
Letter'').
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On June 26, 2008, FINRA filed Amendment No. 2 to the proposed rule
change to address an inconsistency in the application of the proposed
minimum price-improvement provisions identified by the commenter.\7\
Amendment No. 2 was published for comment in the Federal Register on
July 14, 2008.\8\ The Commission received one additional comment letter
on the proposed rule change.\9\ This order approves the proposed rule
change, as modified by Amendment No. 2.
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\7\ On May 20, 2008, FINRA filed Amendment No. 1 to the proposed
rule change. Amendment No. 2 superseded and replaced Amendment No.
1.
\8\ See Securities Exchange Act Release No. 58114 (July 7,
2008), 73 FR 40407 (``Release No. 34-58114'').
\9\ See Letter from R. Cromwell Coulson, Chief Executive
Officer, Pink OTC Markets Inc. (``Pink OTC''), to Secretary,
Commission, dated September 3, 2008. (``Pink OTC Letter'').
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II. Description of the Proposed Rule Change
A. Background
On February 26, 2007, the Commission approved the NASD's proposed
rule change \10\ that expanded the scope of IM-2110-2 \11\ (referred to
as the Manning Rule) to apply to over-the-counter (``OTC'') equity
securities.\12\ In Release No. 34-55351, the Commission also approved,
for both National Market System (``NMS'') and OTC equity securities,
the minimum level of price-improvement that a member must provide to
trade ahead of an unexecuted customer limit order (``price-improvement
standards'').
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\10\ See Securities Exchange Act Release No. 55351 (February 26,
2007), 72 FR 9810 (March 5, 2007) (order approving SR-NASD-2005-146)
(``Release No. 34-55351'').
\11\ Currently, IM-2110-2 generally prohibits a 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.
\12\ See NASD Rule 6610(d) for definition of ``OTC equity
security.''
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In Release No. 34-55351, the price-improvement standards were
modified so that 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 is $0.01. 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 is the lesser
of $0.01 or one-half (\1/2\) of the current inside spread. For customer
limit orders priced outside the best inside market, the member is
required to execute the incoming order at a price at or inside the best
inside market for the security. For customer limit orders in securities
for which there is no published inside market, the minimum amount of
price improvement required is $0.01.
The rule changes adopted in Release No. 34-55351 initially were
scheduled to become effective on July 26, 2007.\13\ However, following
the filing of the instant proposed rule change, SR-NASD-2007-041, FINRA
filed a proposed rule change to delay implementation of the application
of IM-2110-2 to OTC equity securities, until 60 days after Commission
approval of SR-NASD-2007-041.\14\
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\13\ See NASD Notice to Members 07-19 (April 2007).
\14\ See Securities Exchange Act Release No. 56103 (July 19,
2007), 72 FR 40918 (July 25, 2007) (notice of filing and immediate
effectiveness of SR-NASD-2007-039). See also Securities Exchange Act
Release No. 56822 (November 20, 2007), 72 FR 67326 (November 28,
2007) (notice of filing and immediate effectiveness of SR-FINRA-
2007-023); and Securities Exchange Act Release No. 57133 (January
11, 2008), 73 FR 3500 (January 18, 2008) (notice of filing and
immediate effectiveness of SR-FINRA-2007-038). Modifications to the
price-improvement standards applicable to NMS stocks approved in
Release No. 34-55351 became effective on July 26, 2007. See FINRA
Member Alert dated June 20, 2007.
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B. NASD 2007-041
In SR-NASD-2007-041, FINRA proposed to amend the minimum price-
improvement standards set forth in IM-2110-2 to include new tiered
standards that vary according to the price of the customer limit order.
FINRA proposed to revise the minimum price-improvement standards to
address three issues. First, because the minimum price improvement
standards are determined based on the lesser of a specified amount
($.01) or one-half (\1/2\) of the inside spread, the specified amount
acts as an ``upper limit'' on the minimum price improvement
requirement. FINRA believed that the specified amount or upper limit on
the minimum price improvement requirement (i.e., $.01) is
disproportionately high for securities trading below $.01 and that it
should vary proportionately with the amount of the limit order price.
FINRA proposed that, for customer limit orders priced less than $.01
but greater than or equal to $0.001, the minimum amount of price
improvement required would be the lesser of $0.001 or one-half (\1/2\)
of the current inside spread. For customer limit orders priced less
than $.001 but greater than or equal to $0.0001, the minimum amount of
price improvement required would be the lesser of $0.0001 or one-half
(\1/2\) of the current inside spread. For customer limit orders priced
less than $.0001 but greater than or equal to $0.00001, the minimum
amount of price improvement required would be the lesser of $0.00001 or
one-half (\1/2\) of the current inside spread.\15\ Finally, for
customer limit orders priced less than $.00001, the minimum amount of
price improvement required would be the lesser of $0.00001 or one-half
(\1/2\) of the current inside spread.\16\
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\15\ The proposed minimum price-improvement provisions in this
proposed rule change do not supersede, alter or otherwise affect any
of the minimum pricing increment restrictions under Rule 612 of
Regulation NMS. Rule 612 of Regulation NMS prohibits market
participants from displaying, ranking, or accepting bids or offers,
orders, or indications of interest in any NMS stock priced in an
increment smaller than $0.01 if the bid or offer, order, or
indication of interest is priced equal to or greater than $1.00 per
share. If the bid or offer, order, or indication of interest in any
NMS stock is priced less than $1.00 per share, the minimum pricing
increment is $0.0001. See Securities Exchange Act Release No. 51808
(June 9, 2005), 70 FR 37496 (June 29, 2005) (Regulation NMS Adopting
Release).
\16\ For customer limit orders in securities for which there is
no published inside market, the minimum amount of price improvement
required would default to the same tiered minimum price improvement
standards.
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In addition, FINRA proposed that the current minimum price
improvement standard for limit orders priced greater than or equal to
$1.00 would be $.01, and this standard would apply uniformly to NMS
stocks \17\ and OTC equity securities. However, given that subpenny
quoting and trading is permissible in OTC equity securities
[[Page 54651]]
priced at or over $1.00 (and therefore subpenny spreads are possible),
FINRA believed that the minimum price improvement standard should be
adjusted to also include a measure based on the inside spread,
consistent with the standards for customer limit orders priced below
$1.00. Accordingly, FINRA proposed that for customer limit orders in
OTC equity securities priced greater than or equal to $1.00, the
minimum amount of price improvement required should be the lesser of
$0.01 or one-half (\1/2\) of the current inside spread.\18\
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\17\ See Rule 600(b)(47) of Regulation NMS for definition of
``NMS stock.'' 17 CFR 242.600(b)(47).
\18\ Other than the proposed distinction to address permissible
subpenny quoting and trading in OTC equity securities priced over
$1.00, the proposed price-improvement standards would apply
uniformly to NMS stocks and OTC equity securities. See supra note
14.
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Finally, FINRA proposed to change the minimum price-improvement
standard for limit orders priced outside the inside market. According
to FINRA, although trades typically occur at or inside the best inside
market, firms may trade proprietarily outside the best inside market
for a variety of reasons, such as where there is little or no depth at
the inside market or the inside market is manual or not easily
accessible. Under current requirements, such trades could trigger
execution obligations with respect to all limit orders priced outside
the inside market, no matter how far outside the inside market the
limit order is priced. FINRA provided an example that assumed that the
best inside market for a security is $.50 to $.51. The member displays
a quote to buy at $.49 and also holds a customer limit order to buy
priced at $.45. The member's quotation is accessed by another broker-
dealer and the member buys at $.49. Under current requirements, the
member would be required to fill the customer's purchase order at $.45
because it had not purchased at the inside market of $.50. Stating that
it did not believe that this was an appropriate result, FINRA proposed
that, where the limit order is priced outside the inside market for the
security, the minimum amount of price improvement required must either
meet the same tiered minimum price improvement standards set forth
above or the member must trade at a price at or inside the best inside
market for the security. FINRA believed that this would continue to
require an appropriate amount of price improvement for a member to
trade ahead of a customer limit order, irrespective of whether the
limit order is priced inside or outside the best inside market.
The Commission received one comment letter in response to Release
No. 34-56297.\19\ The Fidessa Corp. Letter supported the proposed rule
change, although the commenter suggested modifying and clarifying the
proposal. In this regard, the commenter noted an inconsistency in the
application of the proposed minimum price-improvement standards in low-
priced securities when the customer limit order and the proprietary
trade fall into different minimum price improvement tiers (e.g., a
customer limit order to sell is priced at $1.00 and the proprietary
trade is at $.998). The commenter provided an example that assumed that
the best inside market for an NMS stock is $.996 to $1.00 and a firm is
holding customer limit orders to sell at prices of $.998 and $1.00. If
the firm sells for its own account at $.996, only customer limit orders
to sell priced below $.998 and from $1.00 up to, but not including,
$1.006 would be protected due to the firm's $.996 triggering
proprietary trade. As a result, the firm would not have an obligation
under IM-2110-2 to protect the more aggressively priced $.998 customer
limit order to sell (i.e., the minimum price improvement standard
applicable to that order is the lesser of $.01 or one-half (\1/2\) of
the current inside spread ($.002 (\1/2\ of $.004)), such that the $.996
proprietary trade would only trigger customer limit orders priced less
than $.998), but would have an obligation to protect the $1.00 customer
limit order to sell (i.e., the minimum price improvement standard
applicable to that order is $.01 such that a $.996 proprietary trade
would trigger customer limit orders priced at $1.00 up to, but not
including, $1.006). The commenter suggested instead that FINRA base the
minimum price-improvement standard on the trade price rather than the
customer limit order price.
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\19\ See Fidessa Corp. letter, supra note 5.
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FINRA responded that the commenter's suggested approach could have
unintended consequences in its application and would require
significant reprogramming by member firms to implement, and therefore
initially did not propose any revisions to the proposal.\20\ FINRA
explained that member firms could choose to provide protection
voluntarily for more aggressively priced customer limit orders that
fall within gaps.\21\
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\20\ See FINRA Response Letter, supra note 6.
\21\ Id.
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Subsequently, however, FINRA proposed in Amendment No. 2. to
require, and codify, as part of IM-2110-2, that any more aggressively
priced customer limit orders also must receive limit order protection.
Under Amendment No. 2, firms would be required to protect any more
aggressively priced customer limit orders triggered under IM-2110-2,
even if those limit orders were not directly triggered by the minimum
price improvement standards of IM-2110-2.\22\ FINRA explained, however,
that it would not mandate any particular order handling procedures or
execution priorities among protected orders. Rather, a firm could
choose any reasonable methodology for the way in which it executes
multiple orders triggered by IM-2110-2, provided that the firm ensures
that such methodology is applied consistently and complies with
applicable rules and regulations.\23\
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\22\ The Fidessa Corp. Letter also sought clarification on the
required price-improvement when the limit order is priced outside
the inside market for the security, to which FINRA responded in the
FINRA Response Letter that the minimum amount of price improvement
required must either meet the same tiered minimum price improvement
standards or the member must trade at a price at or inside the best
inside market for the security. FINRA stated that firms need only to
meet one of the minimum price-improvement options provided for limit
orders priced outside the inside market and may do so on a trade-by-
trade basis.
\23\ FINRA further clarified that this statement refers to the
firm's methodology for executing multiple orders triggered by IM-
2110-2 when their size exceeds the size of the firm's proprietary
order that triggered the customer limit order protection obligation.
Telephone conference, September 11, 2008, between Stephanie Dumont,
Vice President and Director of Capital Markets Policy, FINRA, and
Nancy Sanow, Assistant Director, Division of Trading and Markets,
Commission.
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Using the example above, once the limit order priced at $1.00 is
activated upon the execution of the firm's trade at $.996 (i.e., it is
activated because it is within .01 of the price of the firm's trade), a
firm may implement a methodology that executes all more aggressively
priced customer limit orders first (i.e., the limit order priced at
$.998) before executing the limit order priced at $1.00. The proposed
requirements would only apply in the limited circumstance where a firm
has a limit order that is protected by IM-2110-2, but more aggressively
priced customer limit orders are not protected. Therefore, in the above
example, if the firm was only holding a customer limit order to sell of
$.998 (and not a customer limit order of $1.00), the $.998 order would
not be triggered by the proposed requirements.
The Commission received one comment letter in response to Release
No. 34-58114.\24\ The Pink OTC Letter supported the proposed rule
change, as modified by Amendment No. 2, stating that it was necessary
to correct the anomalous situation where inferior
[[Page 54652]]
priced customer limit orders are protected over superior priced limit
orders, and that ``adoption of SR-NASD-2007-041 without correction of
this anomalous situation would disrupt the orderly functioning of the
market for OTC Equity Securities.''
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\24\ See Pink OTC Letter, supra note 9.
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The Pink OTC Letter also recommended more broadly that the minimum
increments of IM-2110-2 be considered as part of an amendment that
would mandate minimum quote increment tier sizes for OTC equity
securities.\25\ The Pink OTC Letter urged that minimum increments for
price improvement should mirror minimum quote increment tier sizes
established on the Pink Quote interdealer quotation system to create
``a level playing field for all market participants and improve
investor confidence in the market.''
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\25\ Pink OTC attached a study of its 2006 Minimum Quote
Increment Tier Pilot Program. (``Pink OTC Pilot Program'') According
to Pink OTC, the study showed that minimum tier sizes implemented
during the Pink OTC Pilot Program did not result in artificial
widening of spreads or degradation of market quality.
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III. Discussion and Commission's Findings
The Commission has reviewed carefully the proposed rule change, as
modified by Amendment No. 2, and the two comment letters it received,
and finds that the proposed rule change, as modified by Amendment No.
2, 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,\26\ which requires, among
other things, that FINRA rules be designed to promote just and
equitable principles of trade, to foster cooperation and coordination
with the persons engaged in regulating, clearing, settling, processing
transactions in securities, and, in general, to protect investors and
the public interest.\27\
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\26\ See 15 U.S.C. 78o-3(b)(6).
\27\ In approving this proposed rule change, 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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The Commission previously approved revisions to IM-2110-2 to apply
the Manning Rule to OTC equity securities,\28\ and notes that FINRA
delayed its implementation pending Commission approval of the instant
proposed rule change, as amended.\29\
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\28\ See Release No. 34-55351, supra note 10.
\29\ See supra note 13.
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FINRA's proposal would revise the current price-improvement
standards by adding a number of tiers to the minimum price-improvement
standard for customer limit orders priced below $.01; adjusting the
price-improvement standards to also include a measure based on one-half
of the current inside spread for customer limit orders in OTC equity
securities when such limit orders are priced greater than or equal to
$1.00; and changing the price improvement standards for limit orders
priced outside the inside market. The Commission believes that these
revisions to IM-2110-2 are appropriate and reasonably designed to
protect customer limit orders in both NMS stocks and OTC equity
securities.
Fidessa Corp. suggested that the minimum price-improvement
standards should be based on the security's trade price rather than the
limit order price of the customer limit order. The commenter observed
that anomalies can occur at the periphery of the minimum price
improvement tiers for low-priced securities when the minimum price-
improvement requirement is based on the order's price.
In the FINRA Response Letter, FINRA responded that Fidessa Corp.'s
proposed alternative approach would address some of the potential
anomalies in the application of the proposed rule, but could have
unintended consequences in its application and would require
significant reprogramming by the firms to implement. Instead, FINRA
revised its proposal, in Amendment No. 2, to require firms to institute
written policies and procedures to fill those more aggressively priced
customer limit orders ahead of other less aggressively priced limit
orders covered by the Rule. This approach was supported by Pink OTC.
The Commission believes that the revisions in Amendment No. 2 are
reasonably designed to eliminate the anomalies that can occur in the
case of limit orders with prices that straddle the proposed minimum
price-improvement tiers. Although Pink OTC urged that amendments to IM-
2110-2 should be complemented by additional provisions mandating
minimum quote increment tier sizes for OTC equity securities, the
Commission considers this recommendation to be beyond the scope of the
proposed rule change before it.
Accordingly, the Commission believes that the proposed rule change
strikes a reasonable balance between protecting customer limit orders
and enhancing the opportunity for investors to receive superior-priced
limit order executions in OTC equity securities.
For the reasons described above, the Commission believes that the
proposed rule change is consistent with the Act.
IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (SR-NASD-2007-041), as modified by
Amendment No. 2, be, and it hereby is, approved.
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\30\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\30\
Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-22011 Filed 9-19-08; 8:45 am]
BILLING CODE 8010-01-P