[Federal Register Volume 75, Number 109 (Tuesday, June 8, 2010)]
[Proposed Rules]
[Pages 32556-32610]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-13129]
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Part II
Securities and Exchange Commission
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17 CFR Part 242
Consolidated Audit Trail; Proposed Rule
Federal Register / Vol. 75 , No. 109 / Tuesday, June 8, 2010 /
Proposed Rules
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
[Release No. 34-62174; File No. S7-11-10]
RIN 3235-AK51
Consolidated Audit Trail
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
proposing new Rule 613 under Section 11A(a)(3)(B) of the Securities
Exchange Act of 1934 (``Exchange Act'') that would require national
securities exchanges and national securities associations (``self-
regulatory organizations'' or ``SROs'') to act jointly in developing a
national market system (``NMS'') plan to develop, implement, and
maintain a consolidated order tracking system, or consolidated audit
trail, with respect to the trading of NMS securities.
The Commission preliminarily believes that with today's electronic,
interconnected markets, there is a heightened need for regulators to
have efficient access to a more robust and effective cross-market order
and execution tracking system. Currently, many of the national
securities exchanges and the Financial Industry Regulatory Authority,
Inc. (``FINRA'') have audit trail rules and systems to track
information relating to orders received and executed, or otherwise
handled, in their respective markets. While the information gathered
from these audit trail systems aids the SRO and Commission staff in
their regulatory responsibility to surveil for compliance with SRO
rules and the federal securities laws and regulations, the Commission
preliminarily believes that existing audit trails are limited in their
scope and effectiveness in varying ways. In addition, while the SRO and
Commission staff also currently receive information about orders or
trades through the electronic bluesheet (``EBS'') system, Rule 17a-25
under the Exchange Act,\1\ or from equity cleared reports, the
information is limited, to varying degrees, in detail and scope.
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\1\ 17 CFR 240.17a-25.
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A consolidated audit trail would significantly aid in SRO efforts
to detect and deter fraudulent and manipulative acts and practices in
the marketplace, and generally to regulate their markets and members.
In addition, such an audit trail would benefit the Commission in its
market analysis efforts, such as investigating and preparing market
reconstructions and understanding causes of unusual market activity.
Further, timely pursuit of potential violations can be important in
seeking to freeze and recover any profits received from illegal
activity.
DATES: Comments should be received on or before August 9, 2010.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
Send an e-mail to [email protected]. Please include
File No. S7-11-10 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File No. S7-11-10. This file number
should be included on the subject line if e-mail is used. To help us
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/proposed.shtml). Comments
are also available for Web site viewing and printing in the
Commission's Public Reference Room, 100 F Street, NE., Washington, DC
20549 on official business days between the hours of 10 a.m. and 3 p.m.
All comments received will be posted without change; we do not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: Rebekah Liu, Special Counsel, at (202)
551-5665; Jennifer Colihan, Special Counsel, at (202) 551-5642, or
Leigh W. Duffy, Attorney-Adviser, at (202) 551-5928, Division of
Trading and Markets, Securities and Exchange Commission, 100 F Street,
NE., Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
II. Basis for Proposed Rule
III. Description of Proposed Rule
IV. Request for Comments
V. Paperwork Reduction Act
VI. Consideration of Costs and Benefits
VII. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition and Capital Formation
VIII. Consideration of Impact on the Economy
IX. Initial Regulatory Flexibility Act Analysis
X. Statutory Authority
I. Background
The U.S. securities markets have undergone a significant
transformation over the last few decades, and particularly in the last
few years. Regulatory changes and technological advances have
contributed to a tremendous growth in trading volume and the further
distribution of order flow across multiple trading centers. Today's
markets are widely dispersed, with securities often trading on multiple
markets, including over-the-counter (``OTC''). Additionally, products
that are closely related in nature and objective are also traded on
different markets. For example, various markets trade either options on
the S&P 500 index,\2\ futures on the S&P 500 index,\3\ exchange traded
funds (``ETFs'') based on the S&P 500 index,\4\ and options and futures
on those ETFs.\5\ This dispersion of significant trading volume has led
the Commission in the past to ask for comment on how best to enhance
the capability of SROs and the Commission to effectively and
efficiently conduct cross-market supervision of trading activity.\6\
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\2\ The Chicago Board Options Exchange, Incorporated (``CBOE'')
lists options on the S&P 500 Index (SPX) and on the Mini-S&P 500
Index (XSP) (1/10th the value of the S&P 500 Index).
\3\ For example, the Chicago Mercantile Exchange Inc. (``CME'')
offers S&P 500 futures and ``E-Mini'' futures on the S&P 500 Index
($50 x S&P 500 Index price).
\4\ For example, NYSE Arca, Inc. (``NYSE Arca'') lists an ETF
based on the S&P 500 SPDR (SPY) and the iShares S&P 500 Index Fund
(IVV).
\5\ For example, OneChicago, LLC lists futures on the SPY, and
CBOE lists options on the iShares S&P 500 Value Index Fund.
\6\ See infra Section I.G. (discussing past Commission requests
for comment on regulation of intermarket trading).
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The individual SROs are responsible for regulating their markets
and their members.\7\ Further, the Commission has responsibilities to
oversee the SROs, the securities markets, and registered broker-
dealers, and routinely conducts examinations of or investigations into
trading activity as part of its oversight and enforcement programs.\8\
The SROs and the Commission need tools to
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effectively carry out these responsibilities even when trading occurs
on multiple markets. For example, it is important that the SRO and
Commission staff have order and trade data sufficient to monitor cross-
market trading activity, assist with investigations of potential
violations of federal securities laws and exchange rules, and perform
market reconstructions or other analysis necessary to understand
trading activity.\9\ Such information also is important to the
Commission in carrying out its oversight responsibilities.
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\7\ See, e.g., Sections 6(b)(1), 15A(b)(2), and 19(g) of the
Exchange Act, 15 U.S.C. 78f(b)(1), 15 U.S.C. 78o-3(b)(2), and 15
U.S.C. 78s(g).
\8\ See, e.g., Sections 2, 6(b)(1), 10, 15(b)(4)(D) and (E), and
19(h) of the Exchange Act, 15 U.S.C. 78b, 15 U.S.C. 78f(b)(1), 15
U.S.C. 78j, 15 U.S.C. 78o(b)(4)(D) and (E), and 15 U.S.C. 78s(h).
\9\ As discussed below in Sections II and III, the Commission
preliminarily believes that the proposal would improve the ability
of regulators to conduct timely and accurate trading analyses for
market reconstructions and complex investigations, as well as
inspections and examinations. Indeed, the Commission believes that
the proposed consolidated audit trail, if implemented, would have
significantly enhanced the Commission's ability to quickly
reconstruct and analyze the severe market disruption that occurred
on May 6, 2010. If approved and implemented, the proposal also would
enhance the Commission's ability to similarly respond to future
severe market events.
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The SROs' staff currently uses both EBS \10\ and SRO audit trail
data to help fulfill their regulatory obligations.\11\ Commission staff
also uses this data to perform its regulatory oversight obligations.
The Commission and SROs have depended on the bluesheet system for
decades to request trading records from broker-dealers needed for
regulatory inquiries. Most SROs also maintain their own specific audit
trail requirements applicable to their members. As discussed more fully
below, for example, the National Association of Securities Dealers
(``NASD'') \12\ established the Order Audit Trail System (``OATS'')
\13\ in 1996, and the New York Stock Exchange (``NYSE'') implemented
its Order Tracking System (``OTS'') \14\ in 1999. Beginning in 2000,
several of the current options exchanges implemented the Consolidated
Options Audit Trail System (``COATS'').\15\
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\10\ Bluesheets are trading records requested by the Commission
and SROs from broker-dealers that are used in regulatory
investigations to identify buyers and sellers of specific
securities.
\11\ The Commission recently published for comment a proposal to
establish a large trader reporting system. See Securities Exchange
Act Release No. 61908 (April 14, 2010), 75 FR 21456 (April 23, 2010)
(``Large Trader Proposal''). Under that proposal, large traders
would be issued unique identifiers that they would be required to
provide to the broker-dealers that execute transactions on their
behalf, and the broker-dealers would be required to maintain, and
provide to the Commission upon request, transaction records for each
large trader customer. The large trader proposal is designed to
address in the near term the Commission's current need for access to
more information about large traders and their activities. As
discussed below, the Commission anticipates that the proposed
consolidated audit trail discussed in this release, which is much
broader in scope, would take a significant amount of time to fully
implement. This proposal would require that, if the Large Trader
proposal is adopted, the large trader identification number be
reported to the central repository as part of the identifying
customer information. See proposed Rule 613(j)(2).
\12\ In 2007, the NASD and the member-related functions of NYSE
Regulation, Inc., the regulatory subsidiary of the New York Stock
Exchange LLC (``NYSE''), were consolidated. As part of this
regulatory consolidation, the NASD changed its name to FINRA. See
Securities Exchange Act Release No. 56146 (July 26, 2007), 72 FR
42190 (August 1, 2007). FINRA and the National Futures Association
(``NFA'') are currently the only national securities associations
registered with the Commission; however, the NFA has a limited
purpose registration with the Commission under Section 15A(k) of the
Exchange Act, 15 U.S.C. 78o-3(k). See also Securities Exchange Act
Release No. 44823 (September 20, 2001), 66 FR 49439 (September 27,
2001).
\13\ See Securities Exchange Act Release No. 39729 (March 6,
1998), 63 FR 12559 (March 13, 1998) (order approving proposed rules
comprising OATS) (``OATS Approval Order'').
\14\ See Securities Exchange Act Release No. 47689 (April 17,
2003), 68 FR 20200 (April 24, 2003) (order approving proposed rule
change by NYSE relating to order tracking) (``OTS Approval Order'').
\15\ See In the Matter of Certain Activities of Options
Exchanges, Administrative Proceeding File No. 3-10282, Securities
Exchange Act Release No. 43268 (September 11, 2000) (Order
Instituting Public Administrative Proceedings Pursuant to Section
19(h)(1) of the Securities Exchange Act of 1934, Making Findings and
Imposing Remedial Sanctions) (``Options Settlement Order''). See
also, e.g., Securities Exchange Act Release No. 50996 (January 7,
2005), 70 FR 2436 (order approving proposed rule change by CBOE
relating to Phase V of COATS).
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Currently, there is significant disparity in the audit trail
requirements among the exchanges and FINRA, especially with respect to
the information captured by each.\16\ Further, the information for each
must be provided in different formats. The differences result in
inconsistent requirements imposed on exchange and FINRA members, and
also make it difficult to view trading activity across multiple
markets. The lack of uniformity in, and cross-market compatibility of,
SRO audit trails can make detection of illegal trading activity carried
out across multiple markets and multiple products more difficult. The
Commission has voiced concern about the lack of uniformity in, and
cross-market compatibility of, the audit trails in the past.\17\ The
Commission preliminarily believes that these differences may hinder the
ability of the SROs and the Commission to effectively view and regulate
trading activity across markets.
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\16\ See infra Sections I.C, I.D, I.E, and I.F.
\17\ See infra Section I.G.
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Further, risks imposed on the markets by violative conduct can be
substantially increased by automated trading, as market participants
have the ability to trade numerous products and enormous volume in mere
seconds. As trading venues have become more automated, and trading
systems have become computerized, trading volumes have increased
significantly,\18\ and trading has become more dispersed across more
trading centers and therefore more difficult to monitor and trace.\19\
The Commission is concerned that current audit trail requirements are
insufficient to capture in a timely manner all of the information
necessary to efficiently and effectively monitor trading activity in
today's highly automated and dispersed markets. The Commission also is
concerned that the current lack of cohesive, readily available order
and execution information impacts the ability of the SROs and the
Commission staff to effectively perform their respective regulatory and
oversight responsibilities with respect to trading activity by market
participants across markets and products.
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\18\ For example, consolidated average daily share volume and
trades in NYSE-listed stocks increased from just 2.1 billion shares
and 2.9 million trades in January 2005, to 5.9 billion shares (an
increase of 181%) and 22.1 million trades (an increase of 662%) in
September 2009. See Large Trader Proposal, supra note 11, at 21456.
\19\ See, e.g., Securities Exchange Act Release No. 61358
(January 14, 2010), 75 FR 3594 (January 21, 2010) (``Concept Release
on Equity Market Structure'') at 3594-3596.
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A. Electronic Bluesheets and Rule 17a-25
The Commission and the SROs frequently request bluesheets from
broker-dealers to aid in investigations of possible Federal securities
law violations and to create market reconstructions.\20\ Until the late
1980s, bluesheets consisted of questionnaire forms that Commission and
SRO regulatory staff mailed to firms to be manually completed and
returned.\21\ Obtaining bluesheets in this manner was particularly
onerous as there were substantial delays in the production and receipt
of the requested information. Additionally, the data was submitted in a
variety of formats, making analysis time-consuming, and requests could
result in vast amounts of information requiring lengthy manual
examination.\22\
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\20\ See Securities Exchange Act Release No. 44494 (June 29,
2001), 66 FR 35836 (July 9, 2001) (File No. S7-12-00) (``Rule 17a-25
Adopting Release''), at 35836.
\21\ Id.
\22\ See Securities Exchange Act Release No. 25859 (June 27,
1988), 53 FR 25029 (July 1, 1988) (approving both the NYSE and the
American Stock Exchange's (``Amex'') rules for the electronic
submission of transaction information).
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In the late 1980s, as the volume of trading and securities
transactions
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dramatically increased, the manual bluesheet system was replaced by the
EBS system.\23\ The EBS system allows broker-dealers to electronically
submit the requested information in a specific format and transmit it
to the Securities Industry Automation Corporation (``SIAC'').\24\ SIAC
then routes the information to the Commission or to an SRO as
applicable.
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\23\ See Rule 17a-25 Adopting Release, supra note 20, at 3-4.
See also, e.g., id. and Securities Exchange Act Release Nos. 26235
(November 1, 1988), 53 FR 44688 (November 4, 1988) (approving the
CBOE rule for the electronic submission of transaction information);
26539 (February 13, 1989), 54 FR 7318 (February 17, 1989) (approving
the NASD's rule for the electronic submission of transaction
information); and 27170 (August 23, 1989), 54 FR 37066 (September 6,
1989) (approving the Philadelphia Stock Exchange's rule for the
electronic submission of transaction information).
\24\ See Rule 17a-25 Adopting Release, supra note 20, at 35836.
SIAC is a subsidiary of NYSE Euronext and serves as the securities
information processor of the Consolidated Tape Plan (``CTA Plan''),
which governs the dissemination of trade information; the
Consolidated Quotation Plan (``CQ Plan''), which governs the
dissemination of quotation information; and the Options Price
Reporting Authority Plan (``OPRA Plan''), which governs the
dissemination of trade and quotation information for listed options.
In this capacity, it provides real time quotation and transaction
information to market participants.
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The EBS system, supplemented by the requirements of Rule 17a-25
under the Exchange Act,\25\ currently is used by Commission and SRO
regulatory staff primarily to assist the staff in the investigation of
possible federal securities law violations primarily involving insider
trading and other market manipulations, and to conduct market
reconstructions, especially following periods of significant market
volatility.\26\ In its electronic format, the EBS system provides
detailed execution information upon request by the Commission and the
SROs' staff for specific securities during specified time frames.\27\
However, because the EBS system is designed for use in narrowly-focused
enforcement investigations that generally involve trading in particular
securities, it is less useful for large-scale market reconstructions
and analyses involving numerous stocks during peak trading volume
periods.\28\
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\25\ 17 CFR 240.17a-25.
\26\ See Rule 17a-25 Adopting Release, supra note 20, at 35836.
\27\ EBS data does not, however, include the time of execution,
and often does not include the identity of the beneficial owner. See
infra note 147.
\28\ A 1990 Senate Report acknowledged the immense value of the
EBS system, but noted that ``it is designed for use in more narrowly
focused enforcement investigations that generally relate to trading
in individual securities. It is not designed for use for multiple
inquiries that are essential for trading reconstruction purposes.''
See S. Rep. No. 300, 101st Cong., 2d Sess. 2-5 (1990), at 48.
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In 2000, the Commission proposed Rule 17a-25 under the Exchange Act
to supplement the existing EBS system with data elements incorporating
institutional and professional trading strategies, to assist regulatory
staff in reviewing and analyzing EBS data.\29\ Adopted in June
2001,\30\ the rule codified the requirement that broker-dealers submit
to the Commission, upon request, information on their customer and
proprietary securities transactions in an electronic format.\31\ Rule
17a-25 requires submission of the same standard customer and
proprietary transaction information that SROs request through the EBS
system in connection with their market surveillance and enforcement
inquiries.\32\
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\29\ See Securities Exchange Act Release No. 42741 (May 2,
2000), 65 FR 26534 (May 8, 2000) (``Rule 17a-25 Proposing
Release'').
\30\ See Rule 17a-25 Adopting Release, supra note 20.
\31\ Id. at 35836, and 17 CFR 240.17a-25.
\32\ See e.g. NYSE Rule 410A and FINRA Rule 8211.
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Specifically, for a proprietary transaction, Rule 17a-25 requires a
broker-dealer to provide the following information electronically upon
request: (1) Clearing house number or alpha symbol used by the broker-
dealer submitting the information; (2) clearing house number(s) or
alpha symbol(s) of the broker-dealer(s) on the opposite side to the
trade; (3) security identifier; (4) execution date; (5) quantity
executed; (6) transaction price; (7) account number; (8) identity of
the exchange or market where the transaction was executed; (9) prime
broker identifier; (10) average price account identifier; and (11) the
identifier assigned to the account by a depository institution.\33\ For
customer transactions, the broker-dealer also is required to include
the customer's name, customer's address, the customer's tax
identification number, and other related account information.\34\ The
new data elements added by Rule 17a-25--prime broker identifiers,
average price account identifiers, and depository institution account
identifiers--assist the Commission in aggregating, without double-
counting, securities transactions by entities trading through multiple
accounts at more than one broker-dealer.\35\
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\33\ See Rule 17a-25(a)(1) and Rule 17a-25(b)(1)-(3), 17 CFR
240.17a-25(a)(1) and 17 CFR 240.17a-25(b)(1)-(3).
\34\ See Rule 17a-25(a)(2), 17 CFR 240.17a-25(a)(2). Rule 17a-25
also requires broker-dealers to submit, and keep current, contact
person information for requests under the rule. This provision was
designed to ensure that the Commission could effectively direct its
data requests to broker-dealers. See Rule 17a-25 Proposing Release,
supra note 29, at 26537.
\35\ This information was deemed especially necessary for the
creation of massive market reconstructions performed by Commission
staff. See Rule 17a-25 Adopting Release, supra note 20, at 35836.
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B. Equity Cleared Reports
In addition to the EBS system and Rule 17a-25, the Commission also
relies upon the National Securities Clearing Corporation's (``NSCC'')
\36\ equity cleared report for initial regulatory inquiries.\37\ This
report is generated on a daily basis by the SROs and is provided to the
NSCC, in a database accessible by the Commission, and shows the number
of trades and daily volume of all equity securities in which
transactions took place, sorted by clearing member. The information
provided is end of day data and is searchable by security name and
CUSIP number.\38\ Since the information made available on the report is
limited to the date, the clearing firm, and the number of transactions
cleared by each clearing firm on each SRO, it basically serves as a
starting point for an investigation, providing a tool the Commission
can use to narrow down which clearing firms to contact concerning a
transaction in a certain security.
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\36\ NSCC is a subsidiary of the Deposit Trust and Clearing
Corporation and provides centralized clearing information and
settlement services to broker-dealers for trades involving equities,
corporate and municipal debt, American depository receipts, exchange
traded funds, and unit investment trusts.
\37\ The Commission also uses the Options Cleared Report, with
data supplied by the Options Clearing Corporation (``OCC''), for
analysis of trading in listed options. OCC is an equity derivatives
clearing organization that is registered as a clearing agency under
Section 17A of the Exchange Act and operates under the jurisdiction
of both the Commission and the Commodities Futures Trading
Commission (``CFTC'').
\38\ A CUSIP number is a unique alphanumeric identifier assigned
to a security and is used to facilitate the clearance and settlement
of trades in the security.
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C. FINRA's Order Audit Trail System
In 1996, the Commission instituted public administrative
proceedings against the NASD, alleging that it failed to enforce and
investigate potential misconduct by its members.\39\ In settling the
Commission's enforcement action, the NASD was ordered to design and
implement an audit trail to enable it to reconstruct its markets
promptly and effectively surveil them.\40\ The Commission mandated that
the audit trail at a minimum: (1) Provide an accurate time-sequenced
record of orders and transactions, beginning with
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the receipt of an order at the first point of contact between the
broker-dealer and the customer or counterparty, and further documenting
the life of the order through the process including execution,
modification and cancellation; and (2) provide for market-wide
synchronization of clocks used in connection with the new audit trail
system.\41\ In response to the order, the NASD created OATS.\42\
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\39\ See In the Matter of National Association of Securities
Dealers, Inc., Administrative Proceeding File No. 3-9056, Securities
Exchange Act Release No. 37538 (August 8, 1996) (Order Instituting
Public Proceedings Pursuant to Section 19(h)(1) of the Securities
Exchange Act of 1934, Making Findings and Imposing Remedial
Sanctions).
\40\ Id. at 11-12.
\41\ Id.
\42\ See FINRA Rules 7400 to 7470. See also OATS Approval Order,
supra note 13.
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Currently, OATS is used to capture order information reported by
FINRA members in equity securities listed on the Nasdaq Stock Market,
Inc. (``Nasdaq'') and OTC equity securities.\43\ OATS requires
reporting members \44\ to record and report to FINRA \45\ detailed
information covering the receipt and origination of an order,\46\ order
terms, transmission, and modification, cancellation and execution.\47\
Specifically, for each of these stages in the life of an order, FINRA
Rule 7440 requires the recording and reporting of the following
information, as applicable, including but not limited to:
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\43\ FINRA defines an OTC equity security as any equity security
that (1) is not listed on a national securities exchange, or (2) is
listed on one or more regional stock exchanges and does not qualify
for dissemination of transaction reports via the facilities of the
Consolidated Tape. See FINRA Rule 7410(l).
\44\ A reporting member is a member that receives or originates
an order and has an obligation to record and report information
under FINRA Rules 7440 and 7450. A member shall not be considered a
reporting member in connection with an order if the following
conditions are met: (1) The member engages in a non-discretionary
order routing process, pursuant to which it immediately routes, by
electronic or other means, all of its orders to a single reporting
member; (2) the member does not direct and does not maintain control
over subsequent routing or execution by the receiving reporting
member; (3) the receiving reporting member records and reports all
information required under FINRA Rules 7440 and 7450 with respect to
the order; and (4) the member has a written agreement with the
receiving reporting member specifying the respective functions and
responsibilities of each party to effect full compliance with the
requirements of Rule 7440 and 7450. See FINRA Rule 7410(o).
\45\ Each reporting member must record each item of information
required by OATS in electronic form by the end of each business day.
See FINRA Rule 7440(a)(3). Reporting members must transmit to OATS a
report of order information whenever an order is originated,
received, transmitted to another department within the member or to
another member, modified, canceled, or executed. Each report shall
be transmitted on the day such event occurred if the information is
available that day. Order information reports may be aggregated into
one or more transmissions. See FINRA Rule 7450(b)(2).
\46\ OATS recording and reporting requirements apply to any
oral, written, or electronic instruction to effect a transaction in
an equity security listed on the Nasdaq Stock Market or an OTC
equity security that is received by a member from another person for
handling or execution, or that is originated by a department of a
member for execution by the same or another member, other than any
such instruction to effect a proprietary transaction originated by a
trading desk in the ordinary course of a member's market making
activities. See FINRA Rule 7410(j).
\47\ See FINRA Rules 7440 and 7450.
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For the receipt or origination of the order,\48\ the date
and time the order was first originated or received by the reporting
member; a unique order identifier; the market participant symbol of the
receiving reporting member; and the material terms of the order;\49\
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\48\ FINRA Rule 7440 also requires reporting of the account
type; the identification of the department or terminal where an
order is received from a customer; the identification of the
department or terminal where an order is originated by a reporting
member; and the identification of a reporting agent if the agent has
agreed to take on the responsibilities of a reporting member under
Rule 7450. See FINRA Rule 7440(b).
\49\ The specific information required to be reported includes:
The number of shares; designation as a buy or sell or short sale;
designation of the order as market, limit, stop, or stop limit;
limit or stop price; date on which the order expires and if the time
in force is less than one day, the time when the order expires; the
time limit during which the order is in force; any request by a
customer that an order not be displayed, or that a block size be
displayed, pursuant to Rule 604(b) of Regulation NMS; any special
handling requests; and identification of the order as related to a
program trade or index arbitrage trade. See FINRA Rule 7440(b).
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For the internal or external routing of an order, the
unique order identifier; the market participant symbol of the member to
which the order was transmitted; the identification and nature of the
department to which the order was transmitted if transmitted
internally; the date and time the order was received by the market
participant or department to which the order was transmitted; the
material terms of the order as transmitted; \50\ the date and time the
order is transmitted; and the market participant symbol of the member
who transmitted the order;
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\50\ The specific information required includes the number of
shares to which the transmission applies, and whether the order is
an intermarket sweep order. See FINRA Rule 7440(c).
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For the modification or cancellation of an order, a new
unique order identifier; original unique order identifier; the date and
time a modification or cancellation was originated or received; and the
date and time the order was first received or originated; \51\ and
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\51\ For cancellations or modification, the following
information also is required: If the open balance of an order is
canceled after a partial execution, the number of shares canceled;
and whether the order was canceled on the instruction of a customer
or the reporting member. See FINRA Rule 7440(d).
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For the execution of an order, in whole or in part, the
unique order identifier; the designation of the order as fully or
partially executed; the number of shares to which a partial execution
applies and the number of unexecuted shares remaining; the date and
time of execution; the execution price; the capacity in which the
member executed the transaction; the identification of the market where
the trade was reported; and the date and time the order was originally
received.\52\
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\52\ For executions, the reporting member also must report its
market participant symbol; its number assigned for purposes of
identifying transaction data; and the identification number of the
terminal where the order was executed. See FINRA Rule 7440(d).
---------------------------------------------------------------------------
FINRA uses this information to recreate daily market activity for
FINRA's market surveillance activities.\53\
---------------------------------------------------------------------------
\53\ See OATS Reporting Technical Specifications, January 5,
2010, available at http://www.finra.org/web/groups/industry/@ip/@comp/@regis/documents/appsupportdocs/p120686.pdf.
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D. NYSE's Order Tracking System
The Commission instituted public administrative proceedings against
the NYSE in 1999, alleging that the exchange had failed to detect
violations of federal securities laws and its own rules by its
independent floor broker members, failed to police for performance-
based compensation arrangements involving these members, and failed to
adequately surveil them.\54\ In settling the Commission's enforcement
action, the NYSE was ordered to continue its development of an
electronic floor system for the entry of order details prior to
representation on the exchange floor, as well as to design and
implement an audit trail to enable it to effectively surveil and
reconstruct its market promptly, and facilitate the NYSE's effective
enforcement of the federal securities laws and exchange rules.\55\ Like
OATS, this audit trail was required to provide an accurate, time-
sequenced record of orders, quotations and transactions, documenting
the life of an order from receipt through execution or cancellation.
The NYSE also was required to provide for synchronization of all clocks
used in connection with the audit trail.\56\
---------------------------------------------------------------------------
\54\ See In the Matter of New York Stock Exchange, Inc.,
Administrative Proceeding File No. 3-9925, Securities Exchange Act
Release No. 41574 (June 29, 1999) (Order Instituting Public
Proceedings Pursuant to Section 19(h)(1) of the Securities Exchange
Act of 1934, Making Findings and Ordering Compliance with
Undertakings), at 4-5.
\55\ Id. at 28-29.
\56\ Id.
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In response to the Commission's order, the NYSE created OTS.\57\
OTS currently is used for the provision of audit trail data for orders
\58\ in NYSE
[[Page 32560]]
and NYSE Amex-listed cash equity securities by NYSE and NYSE Amex
members, including for orders in NYSE or NYSE Amex-listed cash equity
securities initiated by a NYSE or NYSE Amex member or routed by a NYSE
or NYSE Amex member to another market center for execution.\59\ OTS is
similar in scope to OATS, as detailed information is required to be
recorded for the stages of an order's life, from origination and
receipt and transmittal, through order modification, cancellation, and/
or execution.\60\ Specifically, for each of these stages in the life of
an order, OTS requires the recording of the following information, as
applicable, including but not limited to:
---------------------------------------------------------------------------
\57\ See NYSE Rule 132B, and OTS Approval Order, supra note 14.
\58\ OTS is applicable to all orders in NYSE-listed securities,
regardless of account type (firm or customer). See NYSE Rule
132B(a)(1).
\59\ See Securities Exchange Act Release No. 59022 (November 26,
2008), 73 FR 73683 (December 3, 2008). NYSE Alternext adopted NYSE
Rules 1-1004 as the NYSE Alternext Equities Rules to govern all cash
equities trading on the NYSE Alternext Trading Systems and NYSE
Alternext Bonds. In March 2009, NYSE Alternext changed its name to
NYSE Amex LLC (``NYSE Amex'') (the successor to Amex, see infra note
73). See Securities Exchange Act Release No. 59575 (March 13, 2009),
74 FR 11803 (March 19, 2009).
\60\ See NYSE Rule 132B and NYSE Amex Equities Rule 132B. Each
member or member organization shall, by the end of each business
day, record each item of information required to be recorded under
the rule in such electronic form as is prescribed by the NYSE (or
NYSE Amex) from time to time. See NYSE Rule 132B(a)(3) and NYSE Amex
Equities Rule 132B(a)(3). Members and member organizations shall be
required to transmit to the NYSE or NYSE Amex, in such format as the
applicable exchange may from time to time prescribe, such order
tracking information as the exchange may request. See NYSE Rule 132C
and NYSE Amex Equities Rule 132C.
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For order receipt or origination,\61\ the date and time
the order is originated or received by a member or member organization;
a unique order identifier; market participant symbol; and the material
terms of the order; \62\
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\61\ Members are also required to report: The identification of
the department or terminal where an order is received directly from
a customer; and where the order is originated by a member or member
organization, the identification of the department (if appropriate)
of the member that originated the order. See NYSE Rule 132B(b) and
NYSE Amex Equities Rule 132B(b).
\62\ The specific information required to be reported includes:
Number of shares; designation of the order as a buy or sell;
designation of the order as a short sale; designation of the order
as a market order, limit order, auction market order, stop order,
auction stop order, or ISO; security symbol; limit or stop price;
type of account; the date on which the order expires, and, if the
time in force is less than one day, the time when the order expires;
the time limit during which the order is in force; any request by a
customer that an order not be displayed pursuant to Rule 604(c)
under the Exchange Act; and special handling requests. See NYSE Rule
132B(b) and NYSE Amex Equities Rule 132B(b).
---------------------------------------------------------------------------
For the internal or external routing of an order, the
unique order identifier; the identification of the department to which
an order was transmitted if transmitted internally; the date and time
the order was received by the department receiving a transmitted order;
the market participant symbol assigned to the member or member
organization receiving the transmitted order or notation that the order
was transmitted to a non-member; \63\ the material terms of the order
as transmitted; \64\ and the date and time the order is transmitted;
and
---------------------------------------------------------------------------
\63\ The information required to be reported also includes
whether the order was transmitted and received manually or
electronically; the date the order was first originated or received
by the transmitting member or member organization; and, for each
order to be included in a bunched order, the bunched order route
indicator assigned to the bunched order. See NYSE Rule 132B(c) and
NYSE Amex Equities Rule 132B(c).
\64\ The information required to be reported includes the number
of shares to which the transmission applies. See NYSE Rule 132B(c)
and NYSE Amex Equities Rule 132B(c).
---------------------------------------------------------------------------
For the modification or cancellation of an order, a new
unique order identifier; the original unique order identifier; and the
date and time a modification or cancellation was originated or
received.\65\
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\65\ For cancellations or modifications, the following
information also is required: The order identifier assigned to the
order prior to modification; if the open balance of an order is
canceled after a partial execution, the number of shares canceled;
and whether the order was canceled on the instruction of a customer
or the member or member organization. See NYSE Rule 132B(d) and NYSE
Amex Equities Rule 132B(d).
---------------------------------------------------------------------------
Additionally, the NYSE and NYSE Amex require the recording of
detailed information concerning the receipt, cancellation or execution
of orders in NYSE and NYSE Amex-listed cash equity securities
originated on or transmitted to the exchange floor.\66\ Immediately
following receipt of an order on the floor, the member receiving the
order must record the following information: (1) The material terms of
the order; \67\ (2) a unique order identifier; (3) the clearing member
organization and the identification of the member or member
organization recording order details; \68\ and (4) modification of
terms of the order or cancellation of the order.\69\
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\66\ See NYSE Rule 123 and NYSE Amex Equities Rule 123, each of
which require, among other things, a record of the cancellation of
an order, which must include the time the cancellation was entered,
and a record of the receipt of an execution report, which must
include the time of receipt of the report.
\67\ The specific information required includes the security
symbol; quantity; side of the market; whether the order is a market,
auction market, limit, stop, or auction limit order; any limit or
stop price, discretionary price range, discretionary volume range,
discretionary quote price, pegging ceiling price, pegging floor
price and/or whether discretionary instructions are active in
connection with interest displayed by other market centers; time in
force; designation as held or not held; and any special conditions.
See NYSE Rule 123(e) and NYSE Amex Equities Rule 123(e).
\68\ The required information also includes the system-generated
time of recording order details. See NYSE Rule 123(e) and NYSE Amex
Equities Rule 123(e).
\69\ See NYSE Rule 123(e) and NYSE Amex Equities Rule 123(e).
---------------------------------------------------------------------------
Further, once an order is executed, the following information must
be recorded: (1) The material terms of the execution; \70\ (2) the
unique order identifier; (3) the identity of the firms involved in the
execution; \71\ and (4) certain other information related to the
execution.\72\
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\70\ The specific information required includes security symbol;
quantity; transaction price; and execution time. See NYSE Rule
123(f) and NYSE Amex Equities Rule 123(f).
\71\ The specific information required includes the executing
broker badge number or alpha symbol; the contra side executing
broker badge number or alpha symbol; the clearing firm number or
alpha; and the contra side clearing firm number or alpha. See NYSE
Rule 123(f) and NYSE Amex Equities Rule 123(f).
\72\ The required information includes whether the account for
which the order was executed was that of a member or member
organization or non-member or non-member organization; the
identification of member or member organization which recorded order
details; the date the order was entered into an exchange system; an
indication as to whether this is a modification to a previously
submitted report; settlement instructions; special trade indication
(if applicable); and the Online Comparison System control number.
See NYSE Rule 123(f) and NYSE Amex Equities Rule 123(f).
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E. Consolidated Options Audit Trail System
In September 2000, the Commission instituted public administrative
proceedings against Amex,\73\ CBOE, the Pacific Exchange,\74\ and the
Philadelphia Stock Exchange \75\ for failing to uphold their
obligations to enforce compliance with exchange rules and the federal
securities laws, including those relating to reporting. Specifically,
the Commission alleged that they had either conducted no
[[Page 32561]]
automated surveillance, or inadequate automated surveillance, of trade
reporting and consequently failed to adequately detect noncompliance
with their rules.\76\ In settling the Commission's enforcement action,
the exchanges were required to jointly design and implement COATS to
enable them to reconstruct markets promptly, surveil them, and enforce
compliance with trade reporting, firm quote, order handling, and other
rules.\77\ The exchanges were required to complete this undertaking in
five phases.\78\
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\73\ Amex was acquired by NYSE Euronext on October 1, 2008.
Initially, the successor entity to Amex was established as NYSE
Alternext U.S. LLC, but the name was changed in 2009 to NYSE Amex.
See Securities Exchange Act Release No. 59575 (March 13, 2009), 74
FR 11803 (March 19, 2009).
\74\ In 2001, the Archipelago Exchange LLC (``ArcaEx'') was
established as an electronic trading facility for Pacific Exchange's
subsidiary PCX Equities, Inc. (``PCX Equities''). See Securities
Exchange Act Release No. 44983 (October 25, 2001), 66 FR 55225
(November 1, 2001). In 2005, Archipelago Holdings, Inc., the parent
company of ArcaEx, acquired PCX Holdings, Inc., which included
subsidiaries Pacific Exchange (PCX) and PCX Equities. See Securities
Exchange Act Release No. 52497 (September 22, 2005), 70 FR 56949
(September 29, 2005). The NYSE merged with Archipelago Holdings in
2006. See Securities Exchange Act Release No. 53382 (February 27,
2006), 71 FR 11251 (March 6, 2006). NYSE Arca is the successor to
PCX.
\75\ The Philadelphia Stock Exchange was acquired by The NASDAQ
OMX Group, Inc. in 2008, and is now called NASDAQ OMX Phlx
(``Phlx''). See Securities Exchange Act Release No. 58179 (July 17,
2008), 73 FR 42874 (July 23, 2008).
\76\ See Options Settlement Order, supra note 15, at 12.
\77\ Id. at 22.
\78\ Id. at 22-25.
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In particular, each exchange was required to achieve the following
through its audit trail: (1) Synchronize trading and support system
clocks with all other options exchanges; (2) design and implement a
method to merge all options exchanges' reported and matched transaction
data on a daily basis in a common computer format; (3) incorporate its
quotations and the national best bid and offer as displayed in its
market with the merged transaction data so that it could be promptly
retrieved and merged in the common computer format with other options
exchanges' merged transactions and quotation data; (4) design and
implement an audit trail readily retrievable (in the common computer
format) providing an accurate, time-sequenced record of electronic
orders, quotations and transactions on such exchange, beginning with
the receipt of an electronic order, and further documenting the life of
the order through the process of execution, partial execution, or
cancellation; (5) incorporate into the audit trail all non-electronic
orders so that such orders were also subject to the audit trail
requirements for electronic orders; and (6) design effective
surveillance systems to use this newly available data to enforce the
Federal securities laws and the exchange's rules.\79\
---------------------------------------------------------------------------
\79\ See Options Settlement Order, supra note 15, at 22-25.
---------------------------------------------------------------------------
The exchanges subject to the Options Settlement Order fully
implemented the requirements in 2005. In addition, the International
Securities Exchange, LLC (``ISE''), Boston Options Exchange Group, LLC
(``BOX''), the Nasdaq Options Market (``NOM''), and BATS Options
Exchange Market (``BATS Options'') also comply with the COATS
requirements.\80\
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\80\ See Securities Exchange Act Release Nos. 61154 (December
11, 2009), 74 FR 67278 (December 18, 2009), at 67280 (stating ``ISE
and the other options exchanges are required to populate a
consolidated options audit trail (``COATS'') system in order to
surveil member activities across markets''); 61388 (January 20,
2010), 75 FR 4431 (January 27, 2010), at 4433 (Nasdaq OMX BX filing
amending BOX's fee schedule, with similar language as Release No.
61154); and 61419 (January 26, 2010), 75 FR 5157 (February 1, 2010)
(BATS Exchange, Inc. (``BATS'') represented that BATS Options would
comply with the specifications of COATS in submitting data to create
a consolidated audit trail, as well as receiving COATS data for its
own surveillance purposes).
---------------------------------------------------------------------------
A majority of options exchanges require their members to provide
the following information with respect to orders entered onto their
exchange: (1) The material terms of the order; \81\ (2) order receipt
time; \82\ (3) account type; (4) the time a modification is received;
(5) the time a cancellation is received; (6) execution time; and (7)
the clearing member identifier of the parties to the transaction.\83\
---------------------------------------------------------------------------
\81\ The specific information required includes option symbol;
underlying security; expiration month; exercise price; contract
volume; call/put; buy/sell; opening/closing transaction; price or
price limit; and special instructions.
\82\ The required information also includes identification of
the terminal or individual completing the order ticket.
\83\ See e.g. BATS Rule 20.7; BOX Chapter V, Section 15; CBOE
Chapter VI, Rules 6.24 and 6.51; NOM Rule Chapter V, Section 7; NYSE
Amex Rules 153, Commentary .01, and 962; NYSE Arca Rules 6.67, 6.68,
and 6.69; and Phlx Rules 1063 and 1080.
---------------------------------------------------------------------------
F. Other Audit Trail Requirements
SRO audit trail rules regarding information on orders for NMS
stocks to be recorded by their members, and in some cases provided to
the SRO, tend to be less uniform than SRO audit trail rules relating to
listed options.\84\ Some exchanges and FINRA have detailed audit trail
data submission requirements for their members covering order entry,
transmittal, and execution.\85\ For example, the rules of one exchange
require the recording of the following information for each order
originating with an exchange participant that is given to or received
from another participant for execution, transmitted by an exchange
participant to another market, or originating off the exchange and
transmitted to an exchange participant, and subsequent execution of any
such orders: \86\
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\84\ For purposes of this release, the Commission does not
consider SRO EBS rules to be audit trail rules.
\85\ See Chicago Stock Exchange (``CHX'') Article 11, Rule 3(b);
FINRA Rules 7400 to 7470 (the OATS rules); Nasdaq Rules 6950 to 6958
(substantially similar to the OATS rules); BX Rules 6950 to 6958
(substantially similar to OATS rules); NYSE Rule 123 and 132B; and
NYSE Amex Equities Rule 123 and 132B (OTS rules). See supra Sections
I.C. and I.D. for a discussion of FINRA's OATS rules and the NYSE
and NYSE Amex's OTS rules, respectively.
\86\ See CHX Article 11, Rule 3(b).
---------------------------------------------------------------------------
Information relating to receipt or transmission of the
order, including the material terms of the order; \87\ a unique order
identifier; the identification of the clearing participant and the
participant recording the order details; the date and time of order
receipt or transmission (if applicable); the market or participant to
which the order was transmitted or from which the order was received
(if applicable);
---------------------------------------------------------------------------
\87\ Id. The specific information required includes the symbol;
number or shares or quantity of security; side of the market; order
type; limit and/or stop price; whether the order is agency or
proprietary; whether an order is a bona fide arbitrage order;
whether the order is short; time in force; designation as held or
not held; any special conditions or instructions (including any
customer display instructions and any all-or-none conditions); and
the date and time of any order expiration.
---------------------------------------------------------------------------
Information relating to modifications to or cancellation
of the order, including any modifications to the order, any
cancellation of all or part of the order; the date and time of receipt
and transmission of any modifications to the order or cancellations;
and the identification of the party canceling or modifying the order;
\88\
---------------------------------------------------------------------------
\88\ Id.
---------------------------------------------------------------------------
For executions of the order,\89\ in whole or in part, the
transaction price; the number of shares or quantity executed; the date
and time of execution; the contra party to the execution; and any
settlement instructions.\90\
---------------------------------------------------------------------------
\89\ Id.
\90\ Id. The participant also must record the system-generated
times of recording this required information. This information must
be recorded immediately after the information is received or becomes
available. CHX Article 11, Rule 3(c). Additionally, before any such
orders are executed, exchange participants must record the name or
designation of the account for which the order is being executed.
CHX Article 11, Rule 3(d). This rule does not apply to orders sent
or received through the exchange's matching system or any other
electronic systems the exchange recognizes as providing the required
information in a format acceptable to the exchange. See CHX Article
11, Rule 3, Interpretations and Policies .03.
---------------------------------------------------------------------------
The audit trail rules of the other exchanges incorporate only
standard books and records requirements in accordance with Section 17
of the Exchange Act.\91\
---------------------------------------------------------------------------
\91\ See e.g. National Stock Exchange (``NSX'') Chapter VI, Rule
4.1.; BATS Chapter IV, Rule 4.1; CBOE Rule 15.1 (applicable to
CBSX); ISE Stock Exchange Rule 1400; NYSE Arca Equities Rule 2.24;
15 U.S.C. 78q et seq. For example, one exchange only requires its
members to make and keep books and records and other correspondence
in conformity with Section 17 of the Exchange Act and the rules
thereunder, with all other applicable laws and the rules,
regulations and statements of policy promulgated thereunder, and
with the exchange's rules. See NSX Chapter VI, Rule 4.1.
---------------------------------------------------------------------------
G. Prior Commission Request for Comment
The Commission has previously requested comment regarding cross-
[[Page 32562]]
market regulation, including whether changes should be made to existing
audit trail rules, in two concept releases in 2003 and 2004.\92\
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\92\ See Securities Exchange Act Release Nos. 47849 (May 14,
2003), 68 FR 27722 (May 20, 2003) (File No. S7-11-03) (``Intermarket
Trading Concept Release'') and 50700 (November 18, 2004), 69 FR
71256 (December 8, 2004) (File No. S7-40-04) (``Concept Release
Concerning Self-Regulation'').
---------------------------------------------------------------------------
In 2003, the Commission sought public comment on a petition
submitted by Nasdaq that raised concerns about the impact of market
fragmentation on the trading in, and regulation of trading in, Nasdaq-
listed securities.\93\ Nasdaq, through OATS, collected data from its
members trading Nasdaq-listed securities, which the NASD then used to
surveil for potential rule violations.\94\ Nasdaq requested that the
Commission require all SROs trading Nasdaq-listed securities to
implement an electronic audit trail identical to OATS.\95\ Nasdaq also
noted that the available cross-market audit trail information provided
by the Intermarket Surveillance Group (``ISG'') \96\ was comprised of
audit trail information from each of the exchanges and provided two day
delayed data at the clearing firm level, with time data from non-
synchronized clocks.\97\ Nasdaq believed that the information provided
by ISG was insufficient to identify potentially violative activity.\98\
---------------------------------------------------------------------------
\93\ See letter to Jonathan G. Katz, Secretary, Commission, from
Edward Knight, Executive Vice President and General Counsel, Nasdaq,
dated April 11, 2003 (File No. 4-479) (``Nasdaq Petition''). In
particular, Nasdaq was concerned over what it deemed ``unequal and
inadequate regulation'' by other markets trading Nasdaq-listed
securities. Id. at 2. See also Intermarket Trading Concept Release,
supra note 92, at 27223.
\94\ See Nasdaq Petition, supra note 93, at 10, and Intermarket
Trading Concept Release, supra note 92, at 27224.
\95\ See Nasdaq Petition, supra note 93, at 11, and Intermarket
Trading Concept Release, supra note 92, at 27224.
\96\ The ISG was created in 1983 and its members include all of
the registered national securities exchanges and FINRA. ISG states
that its goals are to enhance intermarket surveillance, assure the
integrity of trading, and provide investor protection. To achieve
these goals, ISG members share data such as audit trail information
and short interest data among themselves. ISG provides surveillance
tools to supplement its participant members' existing surveillance
systems, such as the ISG Unusual Activity Report and the
Consolidated Equity Audit Trail. These reports are made available
from SIAC to members of ISG and are intended to provide a
consolidated view across all markets of trade, quote, and clearing
activity. See comment letter from Brian F. Colby, Chairman,
Intermarket Surveillance Group, to Jonathan G. Katz, Secretary,
Commission, dated June 18, 2003 (``ISG 2003 Comment Letter'')
(commenting in response to the Intermarket Trading Concept Release).
\97\ See Nasdaq Petition, supra note 93, at 10, and Intermarket
Trading Concept Release, supra note 92, at 27224.
\98\ See Nasdaq Petition, supra note 93, at 10-11, and
Intermarket Trading Concept Release, supra note 92, at 27224.
---------------------------------------------------------------------------
In response to the Intermarket Trading Concept Release, the
Commission received a variety of comments on intermarket surveillance
and order audit trail issues.\99\ Of those commenters that addressed
the general concept of creating a uniform electronic audit trail, some
supported the concept while others did not.\100\
---------------------------------------------------------------------------
\99\ See comment letters from Darla C. Stuckey, Corporate
Secretary, NYSE, to Jonathan G. Katz, Secretary, Commission, dated
June 19, 2003 (``NYSE Comment Letter''); Jeffrey T. Brown, General
Counsel, Cincinnati Stock Exchange, to Jonathan G. Katz, Secretary,
Commission, dated June 19, 2003 (``CSE Comment Letter''); Michael J.
Simon, Senior Vice President and Secretary, International Securities
Exchange, Inc., to Jonathan G. Katz, Secretary, Commission, dated
June 19, 2003 (``ISE Comment Letter''); William O'Brien, Chief
Operating Officer, Brut, LLC, to Jonathan G. Katz, Secretary,
Commission, dated June 19, 2003 (``Brut Comment Letter''); Kim Bang,
President, Bloomberg Tradebook LLC, to Jonathan G. Katz, Secretary,
Commission, dated June 20, 2003 (``Bloomberg Tradebook Comment
Letter''); Donald D. Kittell, Executive Vice President, Securities
Industry Association, to Jonathan G. Katz, Secretary, Commission,
dated June 27, 2003 (``SIA Comment Letter''); Edward J. Joyce,
President and Chief Operating Officer, CBOE, to Jonathan G. Katz,
Secretary, Commission, dated June 30, 2003 (``CBOE Comment
Letter''); W. Hardy Callcott, Senior Vice President and General
Counsel, Charles Schwab & Co., Inc., to Jonathan G. Katz, Secretary,
Commission, dated July 7, 2003 (``Schwab Comment Letter''); Richard
Ketchum, General Counsel, Citigroup, to Jonathan G. Katz, Secretary,
Commission, dated July 8, 2003 (``Citigroup Comment Letter''); John
S. Markle, Associate General Counsel, Ameritrade Holding Corp., to
Jonathan G. Katz, Secretary, Commission, dated July 10, 2003
(``Ameritrade Comment Letter''); and Eric Schwartz, Managing
Director, Goldman Sachs, and Duncan Niederauer, Co-Chief Executive
Officer, Spear, Leeds & Kellogg, to Jonathan G. Katz, Secretary,
Commission, dated July 25, 2003 (``Goldman Sachs and Spear, Leeds &
Kellogg Comment Letter'').
\100\ Of the commenters that clearly commented on the creation
of a uniform intermarket audit trail, Citigroup and Goldman Sachs
and Spear, Leeds & Kellogg were in favor of the idea, and Bloomberg
supported a consolidated audit trail for those SROs trading Nasdaq-
listed securities. See Citigroup Comment Letter, supra note 99, at
6; Goldman Sachs and Spear, Leeds & Kellogg Comment Letter, supra
note 99, at 3-4; and Bloomberg Tradebook Comment Letter, supra note
99, at 3. Brut, CBOE, and the NYSE did not appear to be in favor of
a standardized intermarket audit trail. See Brut Comment Letter,
supra note 99, at 5 (arguing for addressing improvements to
surveillances falling short of Exchange Act requirements
individually instead of ``costly and comprehensive technology
overhauls''); CBOE Comment Letter, supra note 99, at 2 (explaining
that it ``supports expanding the use of existing tools and enhancing
[SRO] and Commission coordination to strengthen surveillance and to
achieve more uniform regulation * * *'' and noting that the
Commission could ``play a significant role in achieving uniform SRO
regulation [by] establishing guiding principles on a variety of
areas that affect all SROs.'' CBOE also noted that there should be
enhanced coordination of SRO regulatory efforts through ISG and
through 17d-2 agreements); and NYSE Comment Letter, supra note 99,
at 5 (suggesting linking SRO audit trails in the manner of the ISG
Consolidated Audit Trail).
---------------------------------------------------------------------------
One commenter expressed the view that once broker-dealers have
implemented systems necessary to comply with audit trail requirements,
it would not be incrementally significant from a cost perspective to
supply the same data in a common format to additional SROs, but that
there would be a significant cost if the data to be captured and the
methods of encoding and delivering the data differed from market to
market.\101\ This commenter urged the Commission, if it were to require
all market centers to adopt audit trail requirements, to ensure that
the requirements are uniform and standardized. This commenter
recommended a single standard for real time electronic trade and audit
trail reporting, which would be applicable to all equity securities
traded in the national market regardless of where listed or traded, and
where data would be captured in a central depository, aggregated and
made immediately available to each relevant market center, possibly
through direct electronic data feeds.\102\ Likewise, another commenter
stated that it would be preferable for there to be one uniform audit
trail system, rather than each SRO adopting its own audit trail
requirements and systems, to reduce the potential for conflicting rules
and regulations and duplicative systems and technology
requirements.\103\ Another commenter recommended that if the Commission
determined that the need for a particular SRO to have enhanced audit
trail information outweighs costs to member firms, SROs be required to
coordinate efforts so as to reduce duplication of systems and
regulatory efforts.\104\
---------------------------------------------------------------------------
\101\ See Goldman Sachs and Spear, Leeds & Kellogg Comment
Letter, supra note 99, at 3.
\102\ Id at 4.
\103\ See Citigroup Comment Letter, supra note 99, at 6.
\104\ See SIA Comment Letter, supra note 99, at 4. One commenter
agreed that the Commission would be justified in requiring all SROs
trading Nasdaq-listed securities to coordinate electronic audit
trail systems with the NASD. See Bloomberg Tradebook Comment Letter,
supra note 99. On the other hand, one commenter stated its belief
that if there is a legitimate need to improve on the ISG audit
trail, the markets should act jointly to do so, without being forced
to adopt Nasdaq's proprietary audit trail. See ISE Comment Letter,
supra note 99.
---------------------------------------------------------------------------
Several commenters urged the Commission to consider the costs to
broker-dealer firms of supplying the audit trail data when considering
the appropriateness of extending OATS-like audit trail requirements to
other market centers.\105\ One commenter stated the
[[Page 32563]]
belief that firms already are required to maintain all of the customer
and transaction information that regulators would want under their
current books and records requirements and that most firms do not
believe there is a justification for requiring firms to spend the money
necessary to send this information to every market center where an
order may be routed.\106\ Another commenter was concerned about the
impact on each individual market's structure of mandating
uniformity.\107\
---------------------------------------------------------------------------
\105\ See SIA Comment Letter, supra note 99, at 4; Goldman Sachs
and Spear, Leeds & Kellogg Comment Letter, supra note 99, at 3
(stating that any decision about extending OATS to other markets
should take into account the costs imposed on SROs, market
intermediaries and the markets); and Ameritrade Comment Letter,
supra note 99, at 3.
\106\ See SIA Comment Letter, supra note 99, at 4.
\107\ See CSE Comment Letter, supra note 99, at 6-7 (noting that
the data formats among exchanges may vary due to structural needs
and system designs; thus, while this commenter advocated that
exchanges should be required to have internal audit trails tracking
orders from inception to execution, it argued that design
flexibility be maintained so that exchanges could create the audit
trail systems best suited to monitor their markets).
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Some commenters supported the ISG as a facilitator of a coordinated
regulation.\108\ One commenter noted that the ISG Consolidated Equity
Audit Trail was a valuable supplement to existing SRO market data.\109\
One commenter also endorsed the ISG audit trail as well as CSE's Firm
Order Submission system,\110\ stating that it was preferable to enhance
these systems rather than conduct a ``mass migration'' to OATS.\111\
The ISG itself stated that no other market had reported any problems
with ISG's timing of the incorporation of the clearing data into the
Consolidated Equity Audit Trail, nor with the delivery of its audit
trail information.\112\
---------------------------------------------------------------------------
\108\ See Ameritrade Comment Letter, supra note 99, at 2; CSE
Comment Letter, supra note 99, at 13; ISE Comment Letter, supra note
99, at 4; and NYSE Comment Letter, supra note 99, at 3.
\109\ See NYSE Comment Letter, supra note 99.
\110\ In its comment letter, CSE stated that its Firm Order
Submission system (``FOS'') was more comprehensive than OATS and
that the exchange had pioneered order audit trail development. See
CSE Comment Letter, supra note 99. In its petition, Nasdaq argued
that FOS was used voluntarily for settling commercial disputes
between traders and was not meant for surveillance. See Nasdaq
Petition, supra note 93, at 4.
\111\ See Brut Comment Letter, supra note 99, at 6.
\112\ See ISG 2003 Comment Letter, supra note 99.
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In 2004, in a release seeking comment on a variety of issues
relating to self-regulation, the Commission again sought public comment
on intermarket surveillance.\113\ The Commission discussed the
individual audit trails developed by several equity markets, COATS, and
ISG's clearing level audit trail.\114\ The Commission suggested that a
more robust intermarket order audit trail for options and equity
markets could enhance the surveillance of order flow and requested
comment on the issue.\115\
---------------------------------------------------------------------------
\113\ See Concept Release Concerning Self-Regulation, supra note
92, at Sections IV.C and V.A.2.
\114\ Id.
\115\ Id. at 71277.
---------------------------------------------------------------------------
One commenter on the Concept Release Concerning Self-Regulation
stated that, because trading in most liquid securities now occurs on
multiple markets, no single SRO could capture a complete picture of all
the trading in each product, all trading by one broker-dealer, and even
all the trading related to a single order.\116\ This commenter stated
its belief that the lack of uniform order and transaction data creates
regulatory gaps and may provide incentives for market participants to
conduct activities on markets where less regulatory data is collected
on an automated basis.\117\ This commenter believed that minimum data-
collection standards should be required to ensure adequate regulation
across all markets, and that consolidating that data would permit
effective intermarket regulation while ensuring that no single market
has a competitive advantage.\118\
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\116\ See comment letter from Robert R. Glauber, Chairman and
Chief Executive Officer, NASD, to Jonathan G. Katz, Secretary,
Commission, dated March 15, 2005 (``NASD Comment Letter''), at 10.
\117\ Id. at 11.
\118\ Id.
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Another commenter gave an example of how it believed the lack of
real time reporting across markets was detrimental to surveillances
relating to certain illegal activities. This commenter stated its
belief that ``effective surveillances relating to insider trading,
market manipulation and stock or options frontrunning in multiple
markets can be hindered because away-market data such as order
information, position limit reports and large position reports (for
options) are not available electronically on a real time or near real
time basis to the SRO that has generated an alert or flag in the course
of its routine surveillance.\119\ This commenter suggested that
consolidating this type of data in real time or near real time would
permit SROs to immediately detect and review all aberrational activity
in the multiple market centers, which could significantly deter or
prevent violative conduct.\120\
---------------------------------------------------------------------------
\119\ See comment letter from Mary Yeager, Secretary, NYSE, to
Jonathan G. Katz, Secretary, Commission, dated March 8, 2005, at 8.
\120\ Id.
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Another commenter stated its belief that the lack of a coordinated
surveillance system is potentially one of the more significant problems
facing the markets, and that as trading strategies become more
sophisticated across multiple markets and national borders, the
potential for sophisticated fraud also increases.\121\ One commenter
recommended a consolidated information base that all regulators could
access, stating that ``having separate and uncoordinated regulatory
data is inefficient and detracts from the quality of regulation.''
\122\ Further, another commenter suggested a voluntary regulatory
cooperative, jointly owned by participant exchanges, that would be the
central regulator for surveillance, investigations and examinations and
would include an electronic interface with the SEC; this commenter
believed that the costs of developing an intermarket consolidated order
audit trail system should be justified by the regulatory value of the
data to be captured.\123\
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\121\ See comment letter from Rebecca T. McEnally, Director, and
Linda L. Rittenhouse, Senior Policy Analyst, Centre for Financial
Market Integrity, to Nancy M. Morris, Secretary, Commission, dated
July 14, 2006, at 6.
\122\ See comment letter from Kim Bang, Chief Executive Officer,
Bloomberg L.P., to Jonathan G. Katz, Secretary, Commission, dated
March 8, 2005, at 4.
\123\ See comment letter from Meyer S. Frucher, Chairman and
Chief Executive Officer, Philadelphia Stock Exchange, to Jonathan G.
Katz, Secretary, Commission, dated March 9, 2005, at 3.
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II. Basis for Proposed Rule
As noted above, the U.S. securities markets have experienced a
dynamic transformation in recent years. Rapid technological advances
and regulatory developments have produced fundamental changes in the
structure of the securities markets, the types of market participants,
the trading strategies employed, and the array of products traded.
Trading of securities has become more dispersed among exchanges and
various other trading venues, including the OTC market. The markets
have become even more competitive, with exchanges and other trading
centers aggressively competing for order flow by offering innovative
order types, new data products and other services, and through fees
charged or rebates provided by the markets. The Commission
preliminarily believes that with today's fast, electronic and
interconnected markets, there is a heightened need for a single uniform
electronic cross-market order and execution tracking system that
includes more information than is captured by the existing SRO audit
trails, and in a uniform format. Such a system would enable SROs to
better fulfill their regulatory responsibilities to monitor for and
investigate illegal activity in their markets and by their members.
Further, the Commission preliminarily believes that such a system would
enable the Commission staff to better carry out its
[[Page 32564]]
oversight of the NMS for securities and to perform market analysis in a
more timely fashion, whether on one market or across markets.
Each national securities exchange and national securities
association must be organized and have the capacity to comply, and
enforce compliance by its members, with its rules, and with the federal
securities laws, rules, and regulations.\124\ The Commission
preliminarily believes that the exchanges and FINRA could more
effectively and efficiently fulfill these statutory obligations if the
SROs had direct, electronic real time access to consolidated and more
detailed order and execution information across all markets.\125\
Likewise, the Commission has the statutory obligation to oversee the
exchanges and associations,\126\ and to enforce compliance by the
members of exchanges and associations with the respective exchange's or
association's rules, and the federal securities laws and
regulations.\127\ The Commission also preliminarily believes that
electronic real time access to consolidated information and more
detailed cross-market order and execution information also would aid
the Commission in carrying out its statutory obligations.
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\124\ See, e.g., Sections 6(b)(1), 19(g)(1) and 15A(b)(2) of the
Exchange Act, 15 U.S.C. 78f(b)(1), 78s(g)(1), and 78o-3(b)(2).
\125\ The Commission notes that, if adopted as proposed, its
Large Trader Proposal would not amend or impact the scope of any of
the existing SRO audit trail rules. See Large Trader Proposal, supra
note 11.
\126\ See, e.g., Sections 2, 6(b), 15A(b), and 19(h)(1) of the
Exchange Act, 15 U.S.C. 78b, 15 U.S.C. 78f(b), 15 U.S.C. 78o-3(b),
and 15 U.S.C. 78s(h)(1).
\127\ See, e.g., Section 19(h)(1) of the Exchange Act, 15 U.S.C.
78s(h)(1).
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Section 11A(a)(3)(B) of the Exchange Act provides in part that the
Commission may, by rule, require SROs to act jointly with respect to
matters as to which they share authority under the Exchange Act in
regulating an NMS for securities.\128\ Pursuant to this authority, the
Commission today is proposing a rule that would require all national
securities exchanges and national securities associations to jointly
submit to the Commission an NMS plan to create, implement, and maintain
a consolidated audit trail that would be more comprehensive than any
audit trail currently in existence.\129\ The proposed Rule would
require the consolidated audit trail to capture certain information
about each order for an NMS security, including the identity of the
customer placing the order and the routing, modification, cancellation
or execution of the order, in real time. In effect, the proposal would
create a time-stamped ``electronic audit trail record or report'' for
every order, and each market participant that touches the order would
be required to report information about certain reportable events, such
as routing or execution of the order.
---------------------------------------------------------------------------
\128\ See Section 11A(a)(3)(B) of the Exchange Act, 15 U.S.C.
78k-1(a)(3)(B).
\129\ See infra Section III for a description of proposed Rule
613.
---------------------------------------------------------------------------
The Commission preliminarily believes that a consolidated order
audit trail, such as the one proposed today, could enhance the ability
of the SROs to carry out their obligations to regulate their markets
and their members. The Commission also preliminarily believes that the
proposed consolidated order audit trail could aid the Commission in
fulfilling its statutory obligations to oversee SROs,\130\ monitor for
the manipulation of security prices,\131\ and detect the use of
manipulative or deceptive devices in the purchase or sale of a
security,\132\ as well as to perform market reconstructions.
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\130\ See, e.g., Sections 6(b)(1) and 19(h) of the Exchange Act,
15 U.S.C. 78f(b)(1) and 78s(h).
\131\ See Section 9 of the Exchange Act, 15 U.S.C. 78i.
\132\ See Section 10 of the Exchange Act, 15 U.S.C. 78j.
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The Commission preliminarily believes that proposed Rule 613 would
benefit the industry, through potential cost reductions, by eliminating
the need for certain SRO and Commission rules that currently mandate
the collection and provision of information, at least with respect to
NMS securities.\133\ The Commission also preliminarily believes that
the proposal would benefit SROs, as well as the NMS for NMS securities,
by ultimately reducing some regulatory costs, which may result in a
more effective re-allocation of overall costs.\134\
---------------------------------------------------------------------------
\133\ See infra Section VI.A (discussion of benefits of the
proposed Rule).
\134\ Id.
---------------------------------------------------------------------------
The Commission recognizes that SRO rules requiring members to
capture and disclose audit trail information already exist, and
considered whether more modest improvements to existing rules, and
corresponding SRO and member systems, would achieve the proposed Rule's
objective at lower cost. For example, the Commission considered whether
to standardize and expand the order information collected by existing
audit trails, the EBS system, Rule 17a-25 and equity cleared reports.
Without centralization of the trading data in a uniform electronic
format, however, the Commission's goals of cross-market comparability
and ready access could not be achieved. Additionally, this approach
would not resolve concerns over how long it takes to obtain order and
execution information because the data is often not available in real
time and is provided only upon request.\135\ Similarly, the Commission
considered whether assuring access to existing audit trails to other
SROs and the Commission would sufficiently advance its goals. Even if
SROs could view order activity on a real time basis on other exchanges,
this would not eliminate the need for SROs to check multiple
repositories to view and obtain order information. Moreover, the
information may be captured, stored and displayed in a variety of
formats, making comparisons more difficult. The Commission, therefore,
preliminarily does not believe that ``retrofitting'' existing rules and
systems would be a more effective way to achieve the goals of the
proposed consolidated audit trail than having the requirements
contained in a single Commission rule, and a single NMS plan.
---------------------------------------------------------------------------
\135\ See infra note 149.
---------------------------------------------------------------------------
As discussed below, the Commission preliminarily believes that
existing audit trails are limited in their scope and effectiveness in
varying ways. SRO and Commission staff also currently obtain
information about orders or trades through the EBS system, Rule 17a-
25,\136\ and from equity cleared reports.\137\ However, as discussed
below, the information provided pursuant to the EBS system, Rule 17a-
25, and the equity cleared reports also is limited, to varying degrees,
in detail and scope.
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\136\ 17 CFR 240.17a-25.
\137\ See supra Sections I.A. and I.B. for a description of the
EBS system, Rule 17a-25, and equity cleared reports.
---------------------------------------------------------------------------
A. Lack of Uniformity of, and Gaps in, Current Required Audit Trail
Information
As noted above, the type of information relating to orders and
executions currently collected by the exchanges and FINRA differs
widely. For example, FINRA's OATS rules and NYSE/NYSE Amex's OTS rules
(as supplemented by the requirements of NYSE and NYSE Amex Rule 123)
both set forth in relative detail the information required to be
recorded by a FINRA, NYSE or NYSE Amex member upon receipt or
origination of an order; following transmission of an order to another
FINRA, NYSE or NYSE Amex member; and following modification,
cancellation or execution of such order.\138\ In contrast, some other
[[Page 32565]]
exchanges' rules only require their members to keep records in
compliance with the member's recordkeeping obligations under Section
17(a) of the Exchange Act and rules thereunder,\139\ rather than
requiring that specific information be captured for orders sent to and
executed on the exchange.\140\ Although Rule 17a-3 under the Exchange
Act \141\ requires that a member make and keep detailed information
with respect to each brokerage order, it does not, for instance,
require information with respect to the routing of the order, or that
each order be assigned a unique order identifier.\142\ Similarly, the
scope of securities covered by existing audit trail rules also differs
among the exchanges and FINRA. FINRA's OATS rules, for instance, apply
to orders for equity securities listed on Nasdaq and OTC securities,
while OTS captures information for orders in NYSE and NYSE Amex-listed
cash equity securities.\143\
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\138\ See FINRA Rules 7400 through 7470, NYSE Rules 123 and
132B, NYSE Amex Equities Rule 123 and 132B, and supra Sections I.C.
and I.D. See also CHX Article II, Rule 3; Nasdaq Rules 6950 to 6958;
and BX Rules 6950 to 6958.
\139\ 15 U.S.C. 78q(a).
\140\ See, e.g., NSX Rules 4.1 and 4.2, NYSE Arca Equities Rule
9.17, and BATS Rule 4.1.
\141\ 17 CFR 240.17a-3.
\142\ Rule 17a-3(a)(6)(i) under the Exchange Act requires that a
member keep a memorandum of each brokerage order given or received
for the purchase or sale of securities, whether executed or not,
showing the terms and conditions of the order and any modification
or cancellation thereof; the account for which it was entered; the
time the order was received; the time of entry; the execution price;
the identity of each associated person, if any, responsible for the
account; the identity of any other person who entered or accepted
the order on behalf of the customer, or, if a customer entered the
order on an electronic system, a notation of that entry; and, to the
extent feasible, the time of execution or cancellation. See 17 CFR
240.17a-3(a)(6)(i).
\143\ See supra Sections I.C. and I.D. See also supra the
discussion in the introduction to Section II relating to the
Commission's consideration of whether ``retrofitting'' existing SRO
audit trail rules and systems would achieve the goals of the
proposed consolidated audit trail.
---------------------------------------------------------------------------
While there is no current requirement that all SROs record the same
information for orders and executions in the same or different
securities, each SRO has a statutory obligation to regulate its market
and its members. The Commission is concerned that the lack of
uniformity as to the type of audit trail information gathered by the
different exchanges and FINRA, and the lack of compatibility in the
format of each SRO's audit trail data, may hinder the ability of SRO
and Commission staff to effectively and efficiently monitor for,
detect, and deter illegal trading that occurs across markets. If a
market participant is engaging in manipulative behavior across various
markets, but the rules of one market do not require its members to
provide detailed information regarding the orders sent to its market,
it may be difficult for regulators to determine that trading activity
on one market was related to trading activity on another market. For
example, Section 9 of the Exchange Act expressly prohibits ``wash
sales.'' \144\ A trader could attempt to disguise such trading by
executing various legs of wash transactions on different markets.
Individual market surveillance based on individual SRO audit trail data
would not always be able to detect this kind of cross-market abuse.
---------------------------------------------------------------------------
\144\ See Section 9(a)(1) of the Exchange Act, 15 U.S.C.
78i(a)(1). Wash sales are transactions involving no change in
beneficial ownership. See Ernst & Ernst v. Hochfelder, 425 U.S. 185,
205 n. 25 (1976).
---------------------------------------------------------------------------
Further, while current order audit trail rules provide a framework
for capturing order information, the Commission is concerned that
certain information about orders and executions that would be useful to
efficient and effective regulation of inter-market trading activity and
prevention of manipulative practices is not captured by existing audit
trails. Most importantly, the existing audit trails do not require
members to provide information identifying the customer submitting an
order, the person with investment discretion for the order, or the
beneficial owner. The identity of this ``ultimate customer,'' however,
often is necessary to tie together potential manipulative activity that
occurs across markets and through multiple accounts at various broker-
dealers. While the Commission notes that exchange and FINRA regulatory
staff, as well as Commission staff, eventually can obtain identifying
customer or beneficial account information by submitting requests for
information through ISG or to various broker-dealers involved in
potentially wrongful activities, this process can result in significant
delays in investigating market anomalies or potentially manipulative
behavior. The Commission preliminarily believes that gaps such as this
in required audit trail information may hinder the ability of
regulatory authorities to enforce compliance with SRO rules and the
federal securities laws, rules, and regulations in a timely manner.
In addition, an exchange's audit trail information effectively ends
when an order is routed to another exchange. For example, although the
NYSE's OTS rule requires a NYSE member or member organization to record
the fact that an order was transmitted to a non-member, the rules do
not require the recording of what subsequently happens to the
order.\145\ Likewise, FINRA's OATS data collection effectively ends if
an order is routed from a member of FINRA to an exchange.\146\ As a
result, key pieces of information about the life of an order may not be
captured, or easily tracked, if an order is routed from one exchange to
another, or from one broker-dealer to an exchange. For example, the
name, or identifier, of a broker-dealer that initially received an
order may be captured by the audit trail of the exchange of which that
broker-dealer is a member when the broker-dealer sends the order to the
exchange. However, if the order is routed to and executed on a second
exchange, the identifying information for that initial broker-dealer
may not be captured by the second exchange's audit trail requirements.
---------------------------------------------------------------------------
\145\ See NYSE Rule 132B(c)(3).
\146\ See FINRA Rule 7440(c)(6). The Commission understands that
FINRA is able to link OATS order information to Nasdaq order and
execution data.
---------------------------------------------------------------------------
Similarly, under current audit trail rules, an incoming order may
be assigned an order identifier by the initial receiving exchange;
however, if the order is routed to a second exchange, there is no
requirement that this order identifier be passed along to or maintained
by the second exchange. Thus, one order that is routed across markets
can have multiple order identifiers, each unique to one exchange. The
Commission preliminarily believes that, from a regulatory standpoint,
the lack of standardized cross-market order identifiers can pose
significant obstacles and delays in effectively detecting and deterring
manipulative behavior because SRO and Commission staff cannot readily
collect the necessary data (that is, they cannot readily piece together
activity related to the same order or the same customer occurring
across several markets) to determine whether violative behavior has
occurred.
Additionally, the Commission is concerned that the data generated
by the EBS system or that is available through the equity cleared
reports also lacks items of information needed to match up order and
trade information across markets to fully understand a particular
trading pattern or to reconstruct a certain type of trading activity.
EBS data does not include the time of execution, and often does not
include the identity of the beneficial owner.\147\ The equity cleared
data also lacks the time of
[[Page 32566]]
execution, as well as time of order receipt, often the identity of the
beneficial owner, the identity of the broker-dealer(s) that received
and/or executed the order (if different from the clearing broker-
dealer), and short sale borrow and fails information. In order to
obtain the time an order was received or the identity of the beneficial
owner, therefore, SRO or Commission staff may take the additional step
of submitting an electronically generated blue sheet request to the
clearing broker-dealer identified in the equity cleared report to ask
that broker-dealer to identify the beneficial ownership of the
account(s) effecting the relevant transactions and/or the introducing
broker,\148\ and this may take a few steps if the clearing broker-
dealer does not know the introducing broker, but only the executing
broker (if different). If the beneficial ownership of the account(s)
was not specified in the clearing broker-dealer's response, the staff
could then ask the introducing broker-dealer for the time an order was
received and the beneficial account holder information. Often,
additional steps are required to identify the beneficial account
holder, such as when the ``customer'' is an omnibus account.
Furthermore, the equity cleared data could be duplicative. For example,
one side of a trade can appear multiple times in the equity cleared
reports because it may be reported by a specialist, a clearing broker-
dealer, and the broker-dealer holding the customer's allocation account
and the customer's trading account.
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\147\ If a customer has an account directly with a clearing
firm, or if an introducing firm clears its customers' transactions
on a fully disclosed basis with the clearing firm, the clearing firm
should be able to identify the beneficial owner of the account on
its EBS response.
\148\ For purposes of this discussion, introducing broker means
the broker-dealer that received or originated the order, and that is
not also the clearing broker.
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The lack of cohesive, readily available order and execution
information creates significant hurdles for investigators at both the
SROs and at the Commission. In order for SROs to investigate potential
violations of their rules and the federal securities laws and rules by
their members, the SROs should have the ability to analyze the
activities of their members taking place across different market
centers. This requires the accumulation and interpretation of data from
numerous, disparate sources sometimes presenting inconsistent
information. Similarly, the experience of the Commission staff shows
that the lack of a consolidated audit trail results in the investment
of significant resources to investigate potential market abuses. For
example, when investigating potential insider trading and other market
manipulations, Commission staff first obtains an equity cleared report
to identify the clearing broker-dealers for trades involving the stock
under investigation and the trading volume for a particular period of
time. Then staff sends document requests to those clearing broker-
dealers to identify the broker-dealers that executed trades in the
stock over that period of time. This process can be complicated further
by potential market manipulators that trade through small introducing
brokers or use offshore corporate accounts and prime brokerage or other
arrangements to conduct transactions. Commission staff also may request
trade data for additional time periods identified during the course of
the investigation, resulting in further delays. Commission staff thus
often must make multiple requests to broker-dealers to obtain
sufficient order information about the purchase or sale of a specific
security to be able to adequately analyze trading. These multiple
requests and responses can take a significant amount of time and delay
the Commission's efforts to analyze the data on an expedited
basis.\149\ While the investigative protocols of each SRO may differ
from those used by the Commission, in each case, collecting,
interpreting and analyzing diverse data sources is labor intensive and
time consuming.
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\149\ Rule 17a-25 (as well as the SRO EBS rules) does not
specify a definitive deadline by which such information must be
furnished to the Commission and, in the Commission's experience,
data collected through the EBS system often is subject to lengthy
delays, particularly with respect to files involving a large number
of transactions over an extended period of time.
---------------------------------------------------------------------------
The Commission is concerned that inadequacies in the current audit
trail rules, EBS system, and equity cleared reports also impede the
ability of SRO or Commission staff to promptly analyze trading
patterns, particularly to prepare market reconstructions. For example,
if Commission staff wants to undertake an analysis of an extreme market
movement over a limited period of time, Commission staff would need to
analyze audit trail information and EBS submissions of trading data to
determine if specific trading strategies, techniques or participants
appeared to be associated with the movement. Because of difficulties in
linking trades in the audit trails with aggregate day-end trading data
in EBS submissions, conducting this analysis is difficult and time-
consuming. While the audit trail data could identify the precise
execution times of trades by particular clearing broker-dealers, it
would not identify the specific customers or beneficial owners involved
in the trades. On the other hand, while EBS submissions provide summary
trading information for particular accounts at the clearing broker-
dealers, they lack execution times for these trades. Further
complications can arise due to the common practice for large traders to
route their orders through multiple accounts at multiple clearing
firms, as well as practices at some firms that use ``average price
accounts'' to effect trades that are eventually settled in multiple
proprietary and/or customer accounts. While these practices are not, in
themselves, improper, their use makes it more challenging to establish
with certainty when trading on behalf of a particular trader was
effected during the trading session.
The Commission preliminarily believes that the proposed
consolidated audit trail would help alleviate the difficulties faced by
Commission staff in performing market reconstructions, such as those
described in the above example, by requiring that national securities
exchanges, national securities associations, and their members provide
order and execution data to one central location, largely on a real
time basis, in a uniform electronic format. Having this information
readily available in a central location would reduce the need for staff
to request and collect such information from multiple broker-dealers
and then examine, analyze and reconcile the disparate information
provided to accurately ``reconstruct'' the market.\150\
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\150\ As discussed, the Commission preliminarily believes that
the proposal would improve the ability of regulators to conduct
timely and accurate trading analyses for market reconstructions and
complex investigations, as well as inspections and examinations.
Indeed, the Commission believes that the proposed consolidated audit
trail, if implemented, would have significantly enhanced the
Commission's ability to quickly reconstruct and analyze the severe
market disruption that occurred on May 6, 2010. If approved and
implemented, the proposal also would enhance the Commission's
ability to similarly respond to future severe market events.
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B. Books and Records Requirements
Because brokers-dealers often are members of several exchanges and
FINRA, they are subject to and must comply with the differing audit
trail rules. Brokers and dealers also have a statutory obligation to
maintain records in compliance with Commission and SRO rules.\151\ As a
result of the differing audit trail rules, brokers and dealers may be
required to keep records to comply with each audit trail rule relating
to trading in a certain security. Thus, some broker-dealers may now
[[Page 32567]]
face significant costs to comply with varying audit trail rules.\152\
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\151\ See Section 17(a)(1) of the Exchange Act, 15 U.S.C.
78q(a)(1), and Rules 17a-3 and 17a-4 under the Exchange Act, 17 CFR
240.17a-3 and 17a-4.
\152\ See Goldman Sachs and Spear, Leeds & Kellogg Comment
Letter, supra note 99, at 3, and SIA Comment Letter, supra note 99,
at 3 (each commenting on the Nasdaq Petition and Intermarket Trading
Concept Release).
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C. Time Lags
Current audit trail rules require that an SRO's members submit
order and execution information by the end of each business day (in the
case of OATS), or in certain cases, upon request by the regulating
entity (for instance, like OTS).\153\ End-of-day or upon request
reporting, by definition, limits regulators' ability to carry out real
time cross-market surveillance and investigations of market anomalies.
The Commission preliminarily believes that end-of-day reporting,
coupled with the current laborious process of identifying the ultimate
customer responsible for a particular securities transaction that may
take several days, weeks or even months, can impact effective oversight
by hindering the ability of SRO regulatory staff to identify
manipulative activity close in time to when it is occurring, and
respond to instances of potential manipulation quickly. This process
also hinders the Commission's ability to detect and investigate
potentially manipulative behavior. Manipulative activity by some market
participants can result in other market participants, such as retail
investors, losing money. The longer that manipulative behavior goes
undetected over time, the greater the potential harm to investors.
Further, timely pursuit of potential violations can be important in
seeking to freeze and recover any profits received from illegal
activity.
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\153\ See supra Sections I.C. and I.D.
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D. Access to Audit Trail Information
While each SRO has direct access to audit trail information
received from its members, as well as its own data relating to orders
received and executed on its market, one SRO cannot directly or easily
access the audit trail information collected by other SROs, despite the
interconnectedness of today's securities markets and the fact that
orders are often routed from one marketplace to another marketplace for
execution. In addition, Commission staff itself does not have immediate
access to the exchanges' and FINRA's audit trail information, and
instead must specifically request that an exchange or FINRA produce its
audit trail information.\154\
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\154\ The different data fields and unique formats of each SRO
audit trail present difficulties for Commission examinations and
investigations, where time constraints can make it impractical to
manually consolidate diverse data sets.
---------------------------------------------------------------------------
The Commission notes that ISG provides a framework for the
voluntary sharing of information and coordination of regulatory efforts
among the exchanges and FINRA to address potential intermarket
manipulations and trading abuses. The Commission believes that ISG
plays an important role in information sharing among markets that trade
the same securities, as well as related securities or futures on the
same products.\155\ However, the information provided to ISG, which is
drawn from each individual exchange's audit trail and books and
records, is not in any uniform or comparable format. In addition,
information is only submitted to ISG upon a request by one of its
members, and the information is not provided by ISG members in real
time. Further, the operation of ISG is not subject to the Commission's
oversight, including approval of what, and how, information is
collected from and shared across SROs. The Commission preliminarily
believes that it is now appropriate to mandate a structure whereby the
regulatory staff of all exchanges and FINRA, as well as the Commission,
can directly access comprehensive uniform cross-market order and
execution information in real time pursuant to Commission rule, rather
than through an information-sharing cooperative governed only by
contract.
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\155\ See supra note 96.
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E. Scalability of the EBS System and Rule 17a-25
Although the EBS system and Rule 17a-25 can be used to obtain
information in conjunction with the SRO audit trail information, the
Commission is concerned with the ability of the EBS system, as enhanced
by Rule 17a-25, to keep pace with changes in the securities markets
over recent years. Various changes in market dynamics have affected the
utility of the EBS system and Rule 17a-25. For example, decimal trading
has increased the number of price points for securities, and the volume
of quotations and orders has correspondingly dramatically increased.
Thus, the volume of transaction data subject to reporting under the EBS
system can be significantly greater than the EBS system was intended to
accommodate in a typical request for data. As a request-based system
that is most useful when targeting trading in a specific security for a
specific time, the EBS system is not well-suited as a broad-based tool
to detect illegal or manipulative activity. The increased use of
sponsored access (or other indirect access to an exchange) also has
made it more difficult to use the EBS system and Rule 17a-25 to
identify the ultimate customer that originates an order because the
member broker-dealer through whom an order is sent to an exchange may
not know the identity of the underlying customer.\156\
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\156\ Indirect access is when a non-member of an exchange
accesses an exchange through a member. For example, to comply with
regulatory obligations such as Rule 611 of Regulation NMS (17 CFR
242.611), exchanges increasingly rely on indirect access to other
exchanges through member broker-dealers of the other exchanges, so
called ``private linkage'' access. Sponsored access is one type of
indirect access and is governed by exchange rules. See, e.g., Nasdaq
Rule 4611(d). The Commission recently proposed rules that would
address sponsored access to exchanges. See Securities Exchange Act
Release No. 61379 (January 26, 2010), 75 FR 4713 (January 29, 2010).
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In addition, the increasing number of alternative trading venues
creates more opportunities for orders to be routed to other markets and
thus can result in delays in producing EBS data as requests must be
made to several broker-dealers in the ``chain'' of an order. Finally,
the increased trading of derivative instruments and products also has
affected the ongoing effectiveness of the EBS system and Rule 17a-25. A
market participant can use derivative instruments and products as a
substitute for trading in a particular equity, and likewise engage in
illegal trading activity in derivative instruments and products.
However, because information related to some derivative instruments
over which the Commission has anti-fraud authority (such as security-
based swaps) is not included within the EBS data or provided pursuant
to Rule 17a-25, the EBS system and Rule 17a-25 are not effective tools
for ascertaining activity in those markets or how that activity may be
affecting the underlying equity market.\157\
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\157\ See infra Section III.A for a discussion of the scope of
products to be covered by the proposed Rule and the intent to expand
the scope to cover other products and transactions.
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In the Commission staff's experience, the EBS is most effective
when investigating or analyzing trading in a small sample of securities
over a limited period of time. But even under those circumstances,
Commission staff often must make multiple requests to broker-dealers to
obtain sufficient order information about the purchase or sale of a
specific security to be able to adequately analyze the suspect trading.
These multiple requests and responses can take a significant amount of
time. The Commission preliminarily believes that the EBS system may no
longer be able to fully support the regulatory
[[Page 32568]]
challenges currently facing SRO and Commission regulatory staff.
The consolidated audit trail that the Commission is proposing today
would provide significant improvements in the order and execution
information available to SRO and Commission staff in several discrete
ways. Among other things, the proposed audit trail would require that
national securities exchanges and national securities associations and
their members submit uniform order and execution information to a
central repository on a real time basis, where possible. National
securities exchanges and associations, and their member firms, would be
required to identify the person with investment discretion for the
order, and beneficial account holder, if different, along with other
key information about the customer or proprietary desk that placed or
originated the order. The proposed consolidated audit trail also would
cover any action taken with respect to the order through execution, or
cancellation, as applicable, and thus would allow regulators to more
easily trace the order from inception to cancellation or
execution.\158\
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\158\ The proposed Rule also would require the reporting of
certain post-trade information. See infra Section III.D.2.
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The Commission preliminarily believes that the proposed audit trail
information would greatly enhance the ability of SRO staff to
effectively monitor and surveil the securities markets on a real time
basis, and thus to detect and investigate illegal activity in a more
timely fashion, whether on one market or across markets. The Commission
also preliminarily believes that the proposal would improve the ability
of Commission and SRO staff to conduct more timely and accurate trading
analysis, as well as to conduct more timely and accurate market
reconstructions, complex enforcement inquiries or investigations, and
inspections and examinations of regulated entities and SROs.
III. Description of Proposed Rule
To help address the deficiencies described above, the Commission is
proposing to adopt a rule that would require national securities
exchanges \159\ and national securities associations \160\ to create
and implement a consolidated audit trail that captures customer and
order event information, in real time, for all orders in NMS
securities, across all markets, from the time of order inception
through routing, cancellation, modification, or execution.
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\159\ National securities exchange is defined in Rule 600(a)(45)
of Regulation NMS as any exchange registered pursuant to Section 6
of the Exchange Act (15 U.S.C. 78f). 17 CFR 242.600(a)(45).
\160\ National securities association is defined in Rule
600(a)(44) of Regulation NMS as any association of brokers and
dealers registered pursuant to Section 15A of the Exchange Act (15
U.S.C. 78o-3). 17 CFR 242.600(a)(44). As noted above, see supra note
12, FINRA currently is the only national securities association to
which the proposal would apply, as the NFA is restricted to
regulating its members who are registered as broker-dealers in
security futures products due to its limited purpose registration
with the Commission under Section 15A(k) of the Exchange Act, 15
U.S.C. 78o-3(k). The NFA could, of course, seek to expand its
current registration. Thus, for ease of reference, this proposal
refers to FINRA but the proposed requirements would apply to any
national securities association registered with the Commission.
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If adopted, the proposed Rule would require each national
securities exchange and national securities association to file jointly
with the Commission on or before 90 days from approval of this proposed
Rule an NMS plan to govern the creation, implementation, and
maintenance of a consolidated audit trail and a central
repository.\161\ The NMS plan would be required to be filed with the
Commission pursuant to, and subject to the requirements of, Rule 608 of
Regulation NMS.\162\ As such, the proposed NMS plan would be published
in the Federal Register and subject to public notice and comment in
accordance with Rule 608(b). Further, the NMS plan filed pursuant to
the proposed Rule, or any amendment to such a plan, would not become
effective unless approved by the Commission or otherwise permitted in
accordance with Rule 608.\163\
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\161\ See infra Section III.F. for a discussion of the central
repository. The proposed Rule would explicitly require each national
securities exchange and national securities association to be a
sponsor of the NMS plan submitted pursuant to the Rule and approved
by the Commission. See proposed Rule 613(a)(4).
\162\ 17 CFR 242.608. See proposed Rule 613(a)(2).
\163\ See proposed Rule 613(a)(5) and 17 CFR 242.608.
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The Commission would expect the exchanges and FINRA to cooperate
with each other and to take joint action as necessary to develop, file,
and ultimately implement a single NMS plan to fulfill this requirement.
The Commission requests comment on this approach. Specifically, the
Commission requests comment on whether requiring the exchanges and
associations to act jointly by filing an NMS plan that would contain
the requirements for a consolidated audit trail is the most effective
and efficient way to achieve the objectives of a consolidated audit
trail. Or, should the Commission require the exchanges and associations
to standardize or otherwise enhance their existing rules? What approach
would be most efficient in improving the ability to monitor cross-
market trading, or undertake market analysis or reconstructions, and
why?
As discussed in further detail below, the proposed Rule would
require that the NMS plan include provisions regarding: (1) The
operation and administration of the NMS plan; (2) the creation and
oversight of a central repository; (3) the data required to be provided
by SROs and their members to the central repository; (4) clock
synchronization; (5) compliance by national securities exchanges,
FINRA, and their members with the proposed Rule and the NMS plan; and
(6) the possible expansion of the NMS plan to products other than NMS
securities.
The proposed Rule is designed to allow the national securities
exchanges and national securities associations to develop the details
of the NMS plan that they believe should govern the creation,
implementation and maintenance of the central repository and
consolidated audit trail, within the parameters set forth in the
proposed Rule. The Commission believes that the national securities
exchanges and national securities associations working jointly are in
the best position to propose for themselves and their members the
specifics of how the consolidated audit trail should be structured and
administered. To this end, the proposed Rule contains a broad framework
within which the exchanges and associations would provide the details
that they believe would result in a functional, cooperative mechanism
to create and maintain a consolidated audit trail, as well as certain
explicit requirements the NMS plan must meet. As noted above, the
proposed NMS plan developed by the exchanges and FINRA would be subject
to public comment and approval by the Commission.
A. Products and Transactions Covered
Proposed Rule 613 would apply to secondary market transactions in
all NMS securities, which means NMS stocks and listed options.\164\ The
Commission ultimately intends for the consolidated audit trail to cover
[[Page 32569]]
secondary market transactions in other securities, including equity
securities \165\ that are not NMS securities, corporate bonds,
municipal bonds, and asset-backed securities and other debt
instruments; \166\ credit default swaps, equity swaps, and other
security-based swaps; and any other products that may come under the
Commission's jurisdiction in the future. Further, the Commission
preliminarily believes that it would be beneficial to provide for the
possible expansion of the consolidated audit trail to include
information on primary market transactions in NMS stocks and other
equity securities that are not NMS stocks, as well as primary market
transactions in debt securities.\167\ Such information could be used to
monitor for violations of certain rules under the Exchange Act, such as
Regulation M and Rule 10b-5 under the Exchange Act.\168\ Further,
FINRA's transaction reporting requirements for debt securities already
cover primary market transactions in debt securities,\169\ and thus
FINRA members should already be recording information relating to such
transactions that could be included in an audit trail. The Commission
proposes that the scope of the Rule initially be limited to secondary
market transactions in NMS securities, however, to allow for a
manageable implementation of the proposed consolidated audit trail, and
because market participants already have experience with audit trails
for these types of transactions in these securities.
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\164\ NMS security is defined in Rule 600(a)(46) of Regulation
NMS to mean any security or class of securities for which
transaction reports are collected, processed, and made available
pursuant to an effective transaction reporting plan, or an effective
national market system plan for reporting transactions in listed
options. 17 CFR 242.600(a)(46). NMS stock is defined in Rule 600(47)
to mean any NMS security other than an option. 17 CFR
242.600(a)(46). A listed option is defined in Rule 600(a)(35) of
Regulation NMS to mean any option traded on a registered national
securities exchange or automated facility of a national securities
association. 17 CFR 242.600(a)(35).
\165\ Equity security is defined in Section 3(a)(11) of the
Exchange Act to include any stock or similar security; or any
security future on any such security; or any security convertible,
with or without consideration, into such a security, or carrying any
warrant or right to subscribe to or purchase such a security; or any
such warrant or right; or any other security which the Commission
shall deem to be of similar nature and consider necessary or
appropriate, by such rules and regulations as it may prescribe in
the public interest or for the protection of investors, to treat as
an equity security. See 15 U.S.C. 78c(a)(11).
Rule 3a11-1 under the Exchange Act defines equity security to
include any stock or similar security, certificate of interest or
participation in any profit sharing agreement, preorganization
certificate or subscription, transferable share, voting trust
certificate or certificate of deposit for an equity security,
limited partnership interest, interest in a joint venture, or
certificate of interest in a business trust; any security future on
any such security; or any security convertible, with or without
consideration into such a security, or carrying any warrant or right
to subscribe to or purchase such a security; or any such warrant or
right; or any put, call, straddle, or other option or privilege of
buying such a security from or selling such a security to another
without being bound to do so. See 17 CFR 240.3a11-1.
\166\ Asset-backed security means a security that is primarily
serviced by the cash flows of a discrete pool of receivables or
other financial assets, either fixed or revolving, that by their
terms convert into cash within a finite time period, plus any rights
or other assets designed to assure the servicing or timely
distributions of proceeds to the security holders; provided that in
the case of financial assets that are leases, those assets may
convert to cash partially by the cash proceeds from the disposition
of the physical property underlying such leases. See 17 CFR
229.1101(c)(1).
\167\ A primary market transaction is any transaction other than
a secondary market transaction and refers to any transaction where a
person purchases securities in an offering. See, e.g., FINRA Rule
6710 (defining two types of primary market transactions for TRACE-
eligible securities, a List or Fixed Offering Price Transaction or a
Takedown Transaction).
\168\ See 17 CFR 242.100 et. seq. and 17 CFR 240.10b-5. Rule 105
prohibits the short selling of equity securities that are the
subject of a public offering for cash and the subsequent purchase of
the offered securities from an underwriter or broker or dealer
participating in the offering if the short sale was effected during
a period that is the shorter of the following: (i) Beginning five
business days before the pricing of the offered securities and
ending with such pricing; or (ii) beginning with the initial filing
of such registration statement or notification on Form 1-A or Form
1-E and ending with the pricing. Thus, Rule 105 prohibits any person
from selling short an equity security immediately prior to an
offering and purchasing the security by participating in the
offering. The primary market transaction data would allow for the
ability to more quickly identify whether any participant in the
offering sold short prior to the offering.
Rule 10b-5 prohibits any act or omission resulting in fraud or
deceit in connection with the purchase or sale of any security. The
primary market transaction data for bonds would allow for
identification of the cost basis for bond purchases by
intermediaries and make it easier to assess whether subsequent mark-
ups to retail investors in primary offerings are fair and reasonable
and, if not, whether there has been a violation of the antifraud
provisions of the federal securities laws.
\169\ See FINRA Rule 6730(a)(5).
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As discussed above, the Commission believes that implementing a
consolidated audit trail for NMS securities would aid the SROs in more
effectively and efficiently carrying out their regulatory
responsibilities. It would also assist the Commission in carrying out
its statutory responsibilities. The Commission further preliminarily
believes that a timely expansion of the scope of the consolidated audit
trail beyond NMS securities would be beneficial, as illegal trading
strategies that the consolidated audit trail would be designed to help
detect and deter, such as insider trading, may involve trading in
multiple related products other than NMS securities across multiple
markets.
For example, the Commission routinely receives information relating
to possible upward manipulation of security prices in violation of
Sections 9(a) and 10(b) of the Exchange Act,\170\ and alleged abusive
short selling in the over-the-counter market, which includes FINRA's
Bulletin Board and Pink Sheets. If the consolidated audit trail were
expanded to cover these securities, it would be possible for SROs and
the Commission to make comparisons between current and historical data
in a more timely manner than is currently possible, to more quickly
determine whether or not a complaint merits additional attention and
the corresponding commitment of enforcement resources. Similarly, to
the extent that instruments currently not considered NMS securities can
be substitutes for long or short positions in NMS securities, having
access to an audit trail that documents trading activity in such
securities would improve the Commission's ability to make a risk
assessment as to information it has received about possibly
manipulative activity.\171\ Having ready access to this information in
an audit trail also would improve the Commission's inspection process
because it would enhance risk assessment and allow for better selection
as to which broker-dealers to examine. For example, the information
would allow for better trend analysis and outlier identification. It
also would improve pre-examination work and the asset verification
process,\172\ and focus document requests, making the examination
process more efficient for the Commission staff and the registrants
subject to the process.
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\170\ 15 U.S.C. 78i(a) and 78j(b).
\171\ The Commission's Division of Enforcement has recently
established an Office of Market Intelligence. This Office, among
other things, conducts intake and triage of investor and industry
referrals that are received by the Commission each year. Currently,
a thorough review of referrals requires extensive resource
allocation as the primary source for evaluating trading data in the
EBS system. Expansion of the consolidated audit trail to non-NMS
securities would allow that Office to evaluate the merits of each
referral faster and more effectively, and more efficiently allocate
enforcement resources to appropriate cases.
\172\ Asset verification is an exam process that attempts to
locate independent information to verify certain customer positions,
transactions, and balances at broker-dealers.
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To help ensure that such an expansion would occur in a reasonable
time and that the systems and technology that would be used to
implement the Rule as proposed are designed to be easily scalable,
proposed Rule 613(i) would require that the NMS plan contain a
provision requiring each national securities exchange and national
securities association that is a sponsor of the plan \173\ to jointly
provide the Commission a document outlining how the sponsors could
incorporate into the consolidated audit trail information with respect
to: (1) Equity securities that
[[Page 32570]]
are not NMS securities; (2) debt securities, including asset-backed
securities; and (3) primary market transactions in NMS stocks, equity
securities that are not NMS securities, and debt securities. The
sponsors specifically would be required to address, among other things,
details for each order and reportable event that they would recommend
requiring to be provided; which market participants would be required
to provide the data; an implementation timeline; and a cost estimate.
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\173\ Sponsor, when used with respect to an NMS plan, is defined
in Rule 600(a)(70) of Regulation NMS to mean any self-regulatory
organization which is a signatory to such plan and has agreed to act
in accordance with the terms of the plan. See 17 CFR 242.600(a)(70).
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The Commission requests comment on the proposed scope of products
to be covered by the consolidated audit trail. Should the consolidated
audit trail initially cover securities other than NMS securities? Why
or why not? The Commission also requests comment on whether the
approach to expand the consolidated audit trail to include the products
and transactions specified above represents an appropriate expansion of
the consolidated audit trail, and what additional capital commitment
would be required by the various market participants to implement such
an expansion. Please be specific in your response with respect to
different products or transactions (e.g. security-based swaps, or
primary market transactions in NMS stocks). Are there other securities
or products that should be identified and included in a future
expansion? What would be the challenges to any expansion to the
products and transactions listed above? Are there any other actions
that the Commission or SROs would need to take to be able to expand the
audit trail to certain products or transactions? Should the Commission
consider expansion to certain products or transactions before others?
The Commission also requests comment on an appropriate and realistic
time frame for including these other products and transactions in the
consolidated audit trail and whether an expansion should be done in
phases.
The Commission also requests comment on whether implementation of
the proposed Rule, which would apply to NMS securities, would have an
impact on trading activity by market participants in products not
initially covered by the proposed Rule. The proposed consolidated audit
trail is designed to provide the SROs and the Commission a tool to more
effectively, and in a more timely manner, identify potential
manipulative or other illegal activity. More timely detection and
investigation of such activity may lead to greater deterrence of future
illegal activity if potential wrongdoers perceive a greater chance of
regulators identifying their activity in a more timely fashion. Do
commenters believe that the existence of the proposed audit trail would
alter market participants' trading behavior, such as by shifting their
trading to products or markets not covered by the proposed Rule to
avoid detection of illegal activity using consolidated audit trail
data? Would the proposal impact a market participant's analysis of the
potential risks and benefits of manipulative activity involving NMS
securities? If so, how so? In addition, to the extent commenters
believe that market participants may alter their trading behavior, such
as by shifting trading to products that are not initially covered by
the proposed Rule to avoid detection of manipulative activity, the
Commission requests comment on the importance of expanding the
consolidated audit trail to cover additional products.
B. Orders and Quotations
The proposed Rule would require that information be provided to the
central repository for every order in an NMS security originated or
received by a member of an exchange or FINRA. The proposed Rule would
define ``order'' to mean: (1) Any order received by a member of a
national securities exchange or national securities association from
any person; (2) any order originated by a member of a national
securities exchange or national securities association; or (3) any bid
or offer.\174\ Thus, the proposed consolidated audit trail would cover
all orders (whether for a customer or for a member's own account) as
well as quotations in NMS stocks and listed options.\175\ Each member
would be required to report to the central repository the origination
of its own orders or quotations, and the SRO to which the member sends
its orders and quotations would be required to report receipt and
execution, if applicable, of those orders and quotations. Because the
origination of the quotations would already be reported to the central
repository by the member, an SRO would not be required to separately
submit to the central repository its best bids and offers that it is
required to submit to the central processors.\176\
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\174\ See proposed Rule 613(j)(4). Bid or offer is defined in
Rule 600(a)(8) of Regulation NMS to mean the bid price or the offer
price communicated by a member of a national securities exchange or
member of a national securities association to any broker or dealer,
or to any customer, at which it is willing to buy or sell one or
more round lots of an NMS security, as either principal or agent,
but shall not include indications of interest. 17 CFR 242.600(a)(8).
\175\ Quotation is defined in Rule 600(a)(62) of Regulation NMS
to mean a bid or an offer. 17 CFR 242.600(a)(62).
\176\ See Rule 601 of Regulation NMS, 17 CFR 242.601.
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The Commission preliminarily believes that the inclusion of orders
for a member's own account (``proprietary orders'') and their bids and
offers in the scope of the consolidated audit trail is necessary and
appropriate to effectively and efficiently carry out the stated
objectives of the consolidated audit trail. The SROs would not be able
to use the consolidated audit trail data to surveil trading by broker-
dealers through their proprietary accounts if that information is not
included in the audit trail. Further, including proprietary orders and
quotations in the consolidated audit trail would permit SROs to harness
the intended benefits of the consolidated audit trail to more
efficiently monitor for violations of SRO rules where the exact
sequence of the receipt and execution of customers orders in relation
to the creation and execution of proprietary orders or quotations is
important to determine whether or not a violation occurred. For
example, SROs would be able to use the consolidated audit trail data to
more efficiently monitor for instances where a broker-dealer receives a
customer order, then sends a proprietary order to one exchange or
updates its quotations on an exchange prior to sending the customer
order to another exchange, in possible violation of the trading ahead
prohibitions in their rules.\177\
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\177\ See, e.g., FINRA Rule 5320 and NYSE Arca Equities Rule
6.16.
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Another example where information on proprietary orders or
quotations would be useful to have included in the consolidated audit
trail is in the investigation of a possible ``spoofing'' allegation. In
those cases, a market participant enters and may immediately cancel
limit orders or quotations in a specific security with the intent of
having those non-bona fide orders or quotations change the national
best bid and national best offer (``NBBO''). Because a market
participant could conduct this activity across multiple markets, using
different accounts, the lack of consolidated data makes it much more
difficult to identify the source of the orders or quotations and thus
to determine whether the quoted price was manipulated or simply
responding to market forces. The Commission therefore preliminarily
believes that having information on proprietary orders and quotations
in the consolidated audit trail along with customer order information
would
[[Page 32571]]
greatly enhance the ability of the SROs to detect potentially violative
activity.
The Commission requests comment on its proposed definition of
``order'' and the scope of the proposed consolidated audit trail.
Specifically, the definition would include orders received and
originated by SRO members, as well as quotations originated by SRO
members. Should it include quotations? Why or why not? Are there any
differences between orders and quotations that should be taken into
account with respect to the information that would be required to be
provided to the central repository with respect to each bid or offer,
or with respect to how, or which entity, should be required to report
quotation information to the central repository? For example, the
Commission understands that out-of-the-money options generate a high
volume of automated quotation updates to reflect changes in the price
of the underlying security, yet these series often have very little
trading activity. Should this type of quotation be required to be
submitted to the central repository? If not, is there any way to
distinguish these quotations from other quotations that commenters
believe should be reported, such as quotations generated by a profit-
seeking algorithm? What is the magnitude of quotation data compared to
order data and trade data, for both NMS stocks and listed options?
Please provide any empirical data. Would there be a significant cost
savings to the submission and collection of certain quotation
information (for example, quotations in listed options) by end-of-day
instead of in real time? If so, please quantify.
The Commission also requests comment with respect to including
proprietary orders as well as customer orders in the scope of the
consolidated audit trail. Specifically, are there any differences
between customer orders and proprietary orders that should be taken
into account with respect to the information that would be required to
be provided to the central repository with respect to proprietary
orders? The Commission also requests comment on how, if at all, the
consolidated audit trail should take into account instances where an
SRO's quotations (which can include orders received from members as
well as quotations) are not actionable, such as when an exchange has a
systems failure. Should non-firm quotations be marked in the
consolidated audit trail to show they are not firm? If so, how would
that be accomplished where it is the exchange making the determination
its quotations are not firm, not the member that submitted the order or
quotation?
C. Persons Required To Provide Information to the Central Repository
Proposed Rule 613 would require, through the mechanism of an NMS
plan and exchange and association rules adopted pursuant to an NMS
plan, national securities exchanges, national securities associations,
and their respective members \178\ to provide certain information
regarding each order and each reportable event \179\ to the central
repository.\180\ The Commission notes that requiring all members to
provide certain information would capture alternative trading systems
(``ATSs'').\181\
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\178\ A member of a national securities exchange is defined in
Section 3(a)(3)(A) of the Exchange Act to mean: (1) Any natural
person permitted to effect transactions on the floor of the exchange
without the services of another person acting as broker; (2) any
registered broker or dealer with which such a natural person is
associated; (3) any registered broker or dealer permitted to
designate as a representative such a natural person; and (4) any
other registered broker or dealer which agrees to be regulated by
such exchange and with respect to which the exchange undertakes to
enforce compliance with the provisions of the Exchange Act, the
rules and regulations thereunder, and its own rules. Further, for
purposes of Sections 6(b)(1), 6(b)(4), 6(b)(6), 6(b)(7), 6(d),
17(d), 19(d), 19(e), 19(g), 19(h), and 21 of the Exchange Act, the
term ``member'' when used with respect to a national securities
exchange also means, to the extent of the rules of the exchange
specified by the Commission, any person required by the Commission
to comply with such rules pursuant to Section 6(f) of this title.
See 15 U.S.C. 78c(a)(3)(A).
A member of a registered securities association is defined in
Section 3(a)(3)(B) of the Exchange Act to mean any broker or dealer
who agrees to be regulated by such association and with respect to
whom the association undertakes to enforce compliance with the
provisions of the Exchange Act, the rules and regulations
thereunder, and its own rules. See Section 3(a)(3)(B) of the
Exchange Act, 15 U.S.C. 78c(a)(3)(B). Section 15(b)(8) of the
Exchange Act, 15 U.S.C. 78o(b)(8), states that it shall be unlawful
for any registered broker or dealer to effect any transaction in, or
induce or attempt to induce the purchase or sale of, any security
(other than commercial paper, bankers' acceptances, or commercial
bills), unless such broker or dealer is a member of a securities
association registered pursuant to Section 15A of the Exchange Act
or effects transactions in securities solely on a national
securities exchange of which it is a member.
Rule 15b9-1(a) under the Exchange Act, 17 CFR 240.15b9-1(a),
generally states that any broker or dealer required by Section
15(b)(8) of the Exchange Act to become a member of a registered
national securities association shall be exempt from such
requirement if it is a member of a national securities exchange;
carries no customer accounts; and has annual gross income derived
from purchases and sales of securities otherwise than on a national
securities exchange of which it is a member in an amount no greater
than $1,000.
\179\ Reportable event would be defined in proposed Rule
613(j)(5) to include, but not be limited to, the receipt,
origination, modification, cancellation, routing, and execution (in
whole or in part) of an order.
\180\ See infra Section III.D. for a detailed discussion of the
information that would be required to be provided to the central
repository, and infra Section III.H.2. for a discussion of the
requirement that the exchanges and FINRA adopt rules to implement
the requirements of the NMS plan for their members.
\181\ An ATS is defined in Rule 300(a) of Regulation ATS. See 17
CFR 242.300(a). Regulation ATS requires ATSs to be registered as
broker-dealers with the Commission, which entails becoming a member
of FINRA and fully complying with the broker-dealer regulatory
regime. See Concept Release on Equity Market Structure, supra note
19, at 3599.
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The Commission's intent is to require any entity acting in a broker
or dealer capacity that would receive an order from a customer or
originate an order for its own account to provide information to the
central repository. The Commission requests comment on whether
requiring all members of each exchange and association to provide the
required information would encompass all broker or dealers or other
persons that would receive or originate orders, as defined in the
proposed Rule. If not, why not? The Commission requests comment on
whether it should, in the alternative, require all brokers and dealers
registered with the Commission to provide such information, rather than
all members of an exchange or association. Would applying the
requirements to registered brokers and dealers encompass all persons
that would be able to receive or originate orders as defined in the
proposed rule? Are there persons that are not registered as a broker or
dealer, and that are not a member of an exchange or association, that
would still receive or originate orders in NMS securities? How should
the Commission address that situation to promote inclusion of all
relevant orders and executions in a consolidated audit trail?
D. Provision of Information to the Central Repository
Proposed Rule 613(c)(1) generally would require the NMS plan to
provide for an accurate, time-sequenced record of orders beginning with
the receipt or origination of an order by a member of a national
securities exchange or national securities association, and further
documenting the life of the order through the process of routing,
modification, cancellation, and execution (in whole or in part). To
effectuate this goal, proposed Rule 613(c)(2) would require the NMS
plan to require each national securities exchange, national securities
association, and member of such exchange or association to collect and
provide to the central repository certain information with respect to
orders in NMS securities.\182\
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\182\ See Sections III.D.1. and III.D.2. below for a detailed
discussion of the information that would be required to be provided
to the central repository.
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[[Page 32572]]
Specifically, the proposed Rule would require the NMS plan to
require each national securities exchange and its members to collect
and provide to the central repository certain order information for
each NMS security registered or listed for trading on such exchange or
admitted to unlisted trading privileges on such exchange.\183\ The
proposed Rule also would require the NMS plan to require each national
securities association and its members to collect and provide to the
central repository certain order information for each NMS security for
which transaction reports are required to be submitted to the
association.\184\ The Commission requests comment on whether requiring
exchanges and their members, and associations and their members, to
report information for orders for these securities to a central
repository is appropriate, and whether the requirements, as proposed,
would cover all NMS securities.\185\
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\183\ See proposed Rule 613(c)(5).
\184\ See proposed Rule 613(c)(6).
\185\ See infra Section III.F. for a discussion of the central
repository.
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As discussed below in Section III.D.1., certain of the information
would be required to be captured and transmitted to the central
repository on a real time basis, meaning immediately and with no built
in delay from when the reportable event occurs.\186\ Other information
would be permitted to be captured and transmitted to the central
repository promptly after the exchange, association, or member receives
the information, but in no instance later than midnight of the day that
the reportable event occurs or the exchange, association, or member
receives such information.\187\ The data collected by the national
securities exchanges, national securities associations, and their
members would be required to be electronically transmitted to the
central repository in a uniform electronic format.\188\
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\186\ See proposed Rule 613(c)(3). See supra note 179 for a
definition of reportable event.
\187\ See proposed Rule 613(c)(4). This requirement to report no
later than midnight on the day that the reportable event occurs or
the exchange, association or member receives the information would
be determined using the local time of the entity reporting the
information to the central repository.
\188\ See proposed Rule 613(c)(2).
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1. Information To Be Provided to the Central Repository in Real Time
As discussed above in Section II.A.4., the Commission preliminarily
believes that requiring the submission of consolidated audit trail
information on a real time basis would help enable more timely cross-
market monitoring or surveillance and investigations of, or other
responses to, market anomalies. Regulators therefore could more easily
and quickly identify manipulative or other undesirable activity. Having
the information available in real time would allow the staff of the
SROs to run certain cross-market surveillances in real time to
ascertain whether anomalous trading activity is occurring, and the SROs
could then more quickly begin an investigation into the suspected
anomalous trading. Timely pursuit of potential violations can be
important in seeking to freeze any profits received from illegal
activity before they are spent or otherwise become unreachable (for
instance, by being transferred out of the country). The Commission also
preliminarily believes that requiring the submission of audit trail
information in real time would enable the Commission to access the
information on a more timely basis than currently is the case, to
support its examination and enforcement activities, as well as its
analysis of market activity.\189\
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\189\ See supra notes 28, 154, and 171 and accompanying text.
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The Commission requests comment as to whether it is feasible to
require the submission of the proposed audit trail information, as
detailed below, to the central repository on a real time basis. If the
information is not submitted on a real time basis, when should the
information be submitted to the central repository? Would real time
order and execution information be useful for cross-market surveillance
and investigations of market anomalies? If so, how? If not, why not?
Please discuss the costs and benefits of recording and transmitting the
data in real time, or not in real time. For example, how would costs
differ between submitting end-of-day data compared to real time data?
Are there categories of information that would be easier to produce on
a real time basis than others? What types of systems modifications by
the exchanges, FINRA, and their respective members would be necessary
to collect and submit the required audit trail information to the
central repository on a real time basis? Please respond with
specificity. The Commission further requests comment on whether the
requirement to report information in real time should be limited to a
specific time period during the day, such as when the markets for
trading NMS stocks and listed options are open for trading? Or some
other time period? How much lower would the cost be to submit data in
real time during trading hours than during the whole day? Or some other
time period? Are there practical issues with requiring real time
reporting throughout the day? Would requiring data to be submitted in
real time all day, as proposed, allow the ability to perform systems
maintenance if necessary? If commenters support the requirement to
report information in real time, do they believe that there are times
during the day when real time reporting may be unnecessary? Why or why
not?
Proposed Rule 613(c)(3) would require the NMS plan to require each
exchange, association, and member to collect and provide to the central
repository on a real time basis details for each order and each
reportable event,\190\ as outlined below. Each exchange, association,
or member would be required to report the information for each order,
for each reportable event, only with respect to an action taken by the
exchange, association, or member. For example, if a member receives an
order from a customer, the member would be required to report the
receipt of that order (with the required information) to the central
repository. If the member then routed that order to an exchange for
execution, the member would be required to report the routing of that
order (with the required information) to the central repository.
Likewise, the exchange would be required to report the receipt of that
order from the member (with the required information) to the central
repository. If the exchange executed the order on its trading
system(s), the exchange would be required to report that execution of
the order (with the required information) to the central repository,
but the member would not also be required to report the execution of
the order to the central repository. If the member executed the order
in the over-the-counter market, however, rather than routing the order
to an exchange (or other market center) for execution, the member would
be required to report the execution of the order to the central
repository.
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\190\ See supra note 179 for a definition of reportable event.
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i. Customer Information
The proposed Rule specifically would require, for the receipt or
origination of each order, information to be reported to the central
repository with respect to the customer that generates the order--
specifically, the beneficial owner(s) of the account originating the
order and the person exercising investment discretion for the account
originating the order, if different from the beneficial owner.\191\ As
discussed above in Section
[[Page 32573]]
II.A.1, such information generally is neither required nor captured on
existing audit trails. While Rule 17a-25 requires broker-dealers to
electronically submit information about customer and proprietary
securities trading, such information is required to be submitted to the
Commission only upon request. The Commission preliminarily believes
that the usefulness of audit trail information for purposes of
effective enforcement and cross-market surveillance of trading activity
would be greatly improved by having the identity of the customer
electronically attached to the report of the receipt or origination of
each order that is sent to the central repository.\192\
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\191\ The proposed Rule would define ``customer'' to mean the
beneficial owner(s) of the account originating the order and the
person exercising investment discretion for the account originating
the order, if different from the beneficial owner(s). See proposed
Rule 613(j)(1). The Commission notes that this proposed definition
of customer is only for purposes of proposed Rule 613, and what
information would be required to be collected and disclosed by
members to the central repository. The Commission does not intend to
alter the responsibilities that broker-dealers are already subject
to pursuant to SRO rules, or the federal securities laws, rules or
regulations or other laws, with respect to the customers (for
example, suitability rules, see, e.g. NASD Rule 2310).
\192\ See supra Section II.A.
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The proposed Rule would require that the NMS plan require, for the
receipt or origination of an order, the provision to the central
repository of information of sufficient detail to identify the
customer.\193\ The Commission preliminarily believes that the customer
name and address would be sufficient detail to identify the customer.
In addition, the proposed Rule would require the provision of customer
account information, which would be defined in proposed Rule 613(j)(2)
to include but not be limited to: (1) The account number; (2) account
type (e.g. options); (3) customer type (e.g., retail, mutual fund,
broker-dealer proprietary); (4) the date the account was opened; and
(5) the large trader identifier (if applicable).\194\ The Commission
preliminarily believes that information on the type of account and when
it was opened would be important to investigations of potential insider
trading. For example, knowing when in time the customer opened the
account in relation to the suspicious trading activity, or whether the
customer changed account authorization to permit options trading just
before suspicious options trading, could be evidence of intent. The
Commission notes that currently any member receiving orders from a
customer would be required, as part of its compliance with its books
and records requirements,\195\ to take reasonable and appropriate steps
to ensure the accuracy of the customer information received. This
should not change, if this proposal were adopted, with respect to
customer information recorded and provided to the central repository.
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\193\ See proposed Rule 613(c)(7)(i)(A).
\194\ See proposed Rule 613(c)(7)(i)(C). See also Large Trader
Proposal, supra note 11.
\195\ See, e.g., Rules 17a-3, 17a-4, and 17a-25 under the
Exchange Act, 17 CFR 240.17a-3, 17a-4, and 17a-25.
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The proposed Rule also would require a unique customer identifier
for each customer.\196\ The unique customer identifier should remain
constant for each customer, and have the same format, across all
broker-dealers. This unique customer identifier would serve a similar
purpose to a customer's social security number or tax identification
number, obviating the need to include that information in the
consolidated audit trail data. The Commission is not proposing to
mandate the method for achieving this requirement, so as to allow those
entities subject to the proposed Rule flexibility to determine the most
practical way to accomplish the requirement of having unique customer
identifiers. However, one alternative could be to have the central
repository be responsible for assigning a unique customer identifier in
response to an input by a member of a customer's social security number
or tax identification number. If the customer already has been assigned
a unique identifier because of a prior request by another member, the
central repository would provide to the member that same identifier. If
no unique identifier has previously been assigned, the central
repository could assign a new one. Access to this part of the central
repository's functionality could be more tightly controlled than access
to the consolidated audit trail data, to help ensure the
confidentiality of the social security or tax identification numbers.
---------------------------------------------------------------------------
\196\ See proposed Rule 613(c)(7)(i)(B).
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The Commission requests comment as to whether each item of
information regarding the customer is necessary for an effective
consolidated audit trail. Is there any additional data that should be
included to help identify the customer submitting the order? The
Commission also requests comment on the proposed definition of
customer. For example, should the definition only include the person
exercising investment discretion? Should the definition include the
beneficial owner? Should the customer information requirement also
include a unique identifier for the particular computer algorithm used
by the firm to generate the order, if applicable? Is there a better way
to identify in the audit trail individual algorithmically-generated
trading strategies? Should each trading desk at a member be required to
have its own unique customer identifier, to the extent the trading desk
is originating orders for the account of the member? This information
on specific algorithms or trading desks could be useful to focus an
inspection or investigation, if regulators could tell from the audit
trail data that there was a pattern of suspicious trading activity from
a specific algorithm or desk.
The Commission requests comment as to what systems modifications,
if any, would be required for members to collect and to provide this
customer identification information to the central repository. Do
broker-dealers currently keep this information electronically? If not,
what changes would need to be made to collect and provide this
information for existing accounts to the central repository? What would
be the cost of converting this information into an electronic,
accessible and linked format? Please be specific in your response.
Further, the Commission requests comment on whether there are laws or
other regulations in non-U.S. jurisdictions that would limit or
prohibit a member from obtaining the proposed customer information for
non-U.S. customers. If so, what are they? How do members currently
obtain such information for such customers? If there are special
difficulties in obtaining customer information from non-US
jurisdictions, how should the consolidated audit trail be modified or
otherwise reflect that difficulty?
The Commission requests comment on other possible ways to develop
and implement unique customer identifiers. For example, who should be
responsible for generating the identifier? The Commission also requests
comment on whether a unique customer identifier, together with the
other information with respect to the customer that would be required
to be provided under the proposed Rule, is sufficient to identify
individual customers. Are there any concerns about how the customer
information will be protected? If so, what steps should be taken to
ensure appropriate safeguards with respect to the submission of
customer information, as well as the receipt, consolidation, and
maintenance of such information in the central repository.
In addition, the Commission requests comment on whether the
requirement to provide customer information to the central repository
in real time would impact market participants' trading activity? If so,
how so? For example, would market participants be hesitant to
[[Page 32574]]
engage in certain legal trading activity because of a concern about
providing customer information in real time? Would market participants
shift their trading activity to products or markets that do not require
the capture of customer information to avoid compliance with this
requirement of the proposed Rule? If so, how should the Commission
address those concerns? On the other hand, would enhanced surveillance
of the markets as a result of the consolidated audit trail attract
additional trading volume to the U.S. markets?
ii. National Securities Exchange, National Securities Association and
Broker-Dealer Identifier Information
Each member originating or receiving an order from a customer, and
each national securities exchange, national securities association, and
member that subsequently handles the order, would be required to
include its own unique identifier in each report it sends to the
central repository for a reportable event. Such an identifier would
allow the Commission and SRO staff to determine which member
facilitated the transaction and assist in assessing compliance with
various SRO or Commission rules, such as the limit order display rule
(Rule 604 of Regulation NMS).\197\ This is especially important for
ensuring that individual customer orders are handled and executed in
accordance with SRO and Commission rules. In addition, routing
decisions are an important aspect in assessing order execution quality
and compliance with a member's duty of best execution. Further, if
applicable, the member receiving an order from a customer would be
required to report an identifier specifying the branch office and the
registered representative at the member receiving the order. These
identifiers would be unique to the exchange, association, member,
branch office, and registered representative.
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\197\ 17 CFR 242.604.
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The proposed Rule would not require that these unique identifiers
``travel'' with an order throughout its life, but would require that
the unique identifier of each member or SRO that is taking an action
with respect to the order be attached to the report of each reportable
event that the member, exchange or association is reporting to the
central repository. Each report in the life of the order would be able
to be linked together at the central repository through the unique
order identifier. Therefore, the Commission preliminarily does not
believe that the unique identifier of each member or market that
touches an order needs to travel with the order for the life of the
order as long as the unique identifier of the member or exchange taking
the action is included. For example, if Member A receives an order from
a customer, Member A would be required to report the receipt of that
order to the central repository and include Member A's unique
identifier. If Member A then routed that order to another member,
Member B, Member A would be required to report the routing of that
order to the central repository and include Member A's unique
identifier as well as the unique identifier of Member B. Likewise,
Member B would be required to report the receipt of that order from
Member A to the central repository and include the unique identifiers
of Member A and Member B. If Member B then routed the order to Exchange
A for execution, Member B would be required to report the routing of
the order to the central repository and include the unique identifier
of Member B and Exchange A, but not Member A.
The Commission requests comment as to who should be responsible for
generating unique identifiers for national securities exchanges,
national securities associations, and their members. Would it be
feasible for each national securities exchange, national securities
association, or member to develop its own identifier for this purpose?
The Commission also requests comment on the level of specificity for
each unique member identifier--should it be designed to identify the
firm, trading desk or individual registered representative? What are
the advantages or disadvantages of requiring a unique identifier that
would allow identification of an individual registered representative
as opposed to just the member entity? The Commission also requests
comment on procedures or safeguards market participants believe are
necessary or appropriate so that these unique identifiers are routed
accurately.
iii. Receipt or Origination of an Order
The proposed Rule would require the NMS plan to require members of
each of the exchanges and FINRA to collect and provide to the central
repository certain key items of information about an order as soon as
the member receives or originates an order, including the customer
information as described above. The proposed Rule would require the
member to report the date and time (to the millisecond) that an order
was originated or received.\198\ The member also would be required to
report the material terms of the order.\199\ Material terms of the
order would be defined to include, but not be limited to, the following
information: (1) The NMS security symbol; (2) the type of security; (3)
price(s) (if applicable); (4) size (displayed and non-displayed); (5)
side (buy/sell); (6) order type; (7) if a sell order, whether the order
is long, short, or short exempt;\200\ (8) if a short sale, the locate
identifier; (9) open/close indicator; (10) time in force (if
applicable); (11) whether the order is solicited or unsolicited; (12)
whether the account has a prior position in the security; (13) if the
order is for a listed option, option type (put/call), option symbol or
root symbol, underlying symbol, strike price, expiration date, and
open/close; and (14) any special handling instructions.\201\
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\198\ See proposed Rule 613(c)(7)(i)(H). Requiring time to the
millisecond is consistent with current industry standards. The SIPs
currently support millisecond time stamps. See, e.g. SIAC's CQS
Output Specifications Revision 40 (January 11, 2010); SIAC's CTS
Output Specifications Revision 55 (January 11, 2010); and Nasdaq's
UTP Plan Quotation Data Feed Interface Specifications Version 12.0a
(November 9, 2009).
\199\ See proposed Rule 613(c)(7)(i)(I).
\200\ A broker or dealer must mark all sell orders of any equity
security as long, short, or short exempt. See Rule 200(g)(1) under
the Exchange Act, 17 CFR 242.200(g)(1). A sell order may be marked
short exempt only if the conditions of Rule 201(c) or (d) under the
Exchange Act are met (17 CFR 242.201(c) and (d)). See Rule
200(g)(2), 17 CFR 242.200(g)(2).
\201\ See proposed Rule 613(j)(3).
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The information described would assist the SROs, and the Commission
as well, in determining the exact time of order receipt or origination,
as well as provide a record of all of the original material terms of an
order. The entry time of orders can be critical information in
enforcement cases. In insider trading investigations, for example, the
entry time of the order may be a critical piece of evidence in
determining whether or not an individual acted with the requisite
scienter to violate the federal securities laws. Similarly, in
investigating possible market abuse violations, such as trading ahead
of a customer order, the relationship between order origination, the
terms of the order, and order entry of various other orders on multiple
venues, may be at issue. As noted above, requiring that the time of a
reportable event be reported in milliseconds is consistent with current
industry standards. The Commission requests comment on whether this is
an appropriate time standard. Do commenters believe that the time
standard should be shorter? If so, what should be the standard, and
why? Would requiring a shorter time standard for reporting actually
provide more
[[Page 32575]]
precision in the timing of events? How would your answer be impacted by
the extent to which market participants' clocks are synchronized?
Alternatively, do commenters believe that it would be more appropriate
to require in the proposed Rule that the time of reporting be
consistent with industry standards, rather than including a specific
time standard (recognizing that the SROs could choose to include a
specific time standard in the NMS plan)?
An open/close indicator currently is required to be submitted to
exchanges for listed option orders \202\ and indicates whether the
trade is opening a new position or increasing an existing position
rather than closing or decreasing an existing position. The open/close
indicator provides information to more easily track the size and
holding time for individual positions, and thus to more easily track
open interest and short interest. In addition, an open/close indicator
could be used to indicate when a buy order in a stock is a buy to cover
on a short sale. This information is useful in investigating short
selling abuses and short squeezes. For example, a build up of a large
short position by one investor along with the spreading of rumors may
be indicative of using short selling as a tool to potentially
manipulate prices. Information on when the position decreases is also
useful for indicating potential manipulation, insider trading, or other
rule violations. Information on whether the account has a prior
position in the security is useful in a number of investigations. For
example, the ability to easily determine whether an order adds to a
position, along with the timing of the order, is particularly important
in detecting and investigating portfolio pumping or marking the close.
Also, information on whether the account has a prior position may be
important in investigating ``layering'' or ``spoofing.'' Layering and
spoofing are manipulations where orders are placed close to the best
buy or sell price with no intention to trade in an effort to falsely
overstate the liquidity in a security.
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\202\ See, e.g., CBOE Rule 6.51; BATS Rule 20.7; and ISE Rule
1404.
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The Commission intends that the items of information required to be
reported to the central repository for the receipt or origination of an
order, at a minimum, include substantially all of the information
currently required to be reported, or provided upon request, under the
exchanges' and FINRA's existing order audit trail rules, as well as the
EBS system rules and Rule 17a-25 under the Exchange Act. The Commission
requests comment as to whether there are any items of information that
are required to be recorded and reported by existing audit trail rules,
or to be provided to the SROs or Commission upon request, that are not
included within the proposed Rule that commenters believe should be
included. If there are, please identify each item of information and
discuss why you believe that such information should be included in the
proposed consolidated audit trail. The Commission also requests comment
on whether there are items of information included in the current SRO
audit trails, and which are proposed to be included in the consolidated
audit trail, that are unnecessary for surveillance, investigative or
other regulatory purposes. If so, what are these data elements and why
are they not necessary as part of a consolidated audit trail? Are they
relevant for other purposes? The Commission further requests comment on
whether it should require, as part of the disclosure of special
handling instructions, the disclosure of an individual algorithm that
may be used by a member or customer to originate or execute an order,
and if so, how such an algorithm should be identified.
As noted above, members currently are required to indicate whether
an order would open or close a position for listed options.\203\ The
Commission requests comment as to what extent members currently obtain
or have access to this information from their customers, or track this
information for their own proprietary orders, for all NMS securities.
If members currently do obtain this information, is the information
collected and stored electronically? If members currently do not have
access to or obtain this information for customer orders, what would be
the impact of the proposed requirement to collect and provide this
information to the central repository? What would be the costs, if any,
of collecting and providing this information? Please explain and
quantify any potential impact or costs.
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\203\ Id.
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The proposed Rule does not specify exact order types (e.g., market,
limit, stop, pegged, stop limit) to be included as material terms of an
order because order types may differ across markets, and even an order
type with the same title may have a different meaning from one exchange
to another. Further, markets are frequently creating new order types
and eliminating existing order types. In addition, the Commission notes
that it may be difficult to distinguish between an ``order type'' and a
special handling instruction, such as ``do not display.'' The
Commission therefore preliminarily believes that it would not be
practical to include in the proposed Rule a list of order types in the
required information to be reported to the central repository. The
Commission notes, however, that the SROs may choose to include more
detail in the NMS plan. The Commission requests comment on this
approach. The Commission also requests comment as to whether there are
other items of information that would be required to be reported to the
central repository that have, or may have, different meanings across
different exchanges. If so, what are they? How should these differences
be addressed in the proposed Rule?
The proposed Rule also would require the NMS plan to require each
member of an exchange or FINRA to ``tag'' each order received or
originated by the member with a unique order identifier that would be
reported to the central repository and that would stay with that order
throughout its life, including routing, modification, execution, and
cancellation.\204\ The members, exchanges, and FINRA would be required
to pass along the unique order identifier with the order when routing
the order, and the unique order identifier would be required on each
reportable event report. For example, Member ABC that receives an order
from a customer would immediately assign it a unique order identifier,
and would report that identifier to the central repository along with
the rest of the required information. If Member ABC subsequently routed
the order to another member, Member DEF, Member ABC would be required
to pass along to Member DEF the unique order identifier, as well as to
attach the unique order identifier when reporting the routing of the
order to the central repository. If Member DEF routed the order to
Exchange A for execution, Member DEF would pass along to Exchange A
with the order the unique order identifier, and would attach the
identifier on the report of the route sent to the central repository.
Exchange A would be required to attach the unique order identifier when
reporting receipt of the order, and an execution of the order (if
applicable) to the central repository.
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\204\ See proposed Rule 613(c)(7)(i)(D).
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The Commission recognizes that the reality of how orders are routed
and executed often is complex, and that it likely is not feasible to
anticipate how the proposed requirement for a unique
[[Page 32576]]
order identifier would or would not apply to each different factual
scenario. For example, members may often execute customer orders on a
``riskless principal'' basis,\205\ rather than on an agency basis. The
Commission preliminarily believes that it would not be practical or
feasible to ``link'' through related unique order identifiers the
customer order(s) and the member's proprietary order(s) from which the
customer order is given an allocation. Rather, the Commission envisions
that the member would create a new unique order identifier for each
proprietary order, and that the manner in which the execution of the
customer order would be ``linked'' with one (or more) proprietary
order(s) (if at all) would be through the inclusion of the unique order
identifier for the contra-side order(s) on the report of the execution
of the customer order sent to the central repository.\206\ However, in
a situation where a member merely broke up a larger customer order into
smaller orders and sent those orders, on an agency basis, to multiple
markets for execution, the Commission preliminarily believes that the
unique order identifier of the original customer order should carry
through in some manner to the individual smaller orders that result
when the original order is broken up. For example, it may be necessary
to attach two unique order identifiers to an order--the original order
identifier (i.e. parent order) and the individual smaller order
identifier (i.e. child order). Alternatively, the unique order
identifier of the parent order could be modified to carry through to
the child orders (for example, the parent order could have an
identifier ABC and the child orders could have identifiers of ABC1 and
ABC2).
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\205\ For example, a member receives a customer order, and
rather than sending the customer order as an agency order to an
exchange or other marketplace to execute, the member creates an
order for its proprietary account that it sends to an exchange or
other marketplace to be executed. Once an execution occurs in the
proprietary account, the member would then execute the customer
order against its proprietary account. This process can be
complicated by the member receiving and handling more than one
customer order at a time, and creating one or more proprietary
orders to send to one or more markets, and the manner in which the
member allocates executions from its proprietary account among the
customer orders.
\206\ See proposed Rule 613(c)(7)(vi)(C).
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The Commission preliminarily believes that a unique order
identifier that is essentially transferred along with an order from
origination through execution or cancellation is useful for a
consolidated audit trail. The use of such an identifier would allow the
SROs and the Commission to efficiently link all events in the life of
an order and help create a complete audit trail across markets and
broker-dealers that handle the order. In this manner, being able to
link the parent order with the child orders through the unique order
identifiers would allow for ease of tracking of the original parent
order throughout its life. While the Commission believes that a unique
order identifier is an important data element for the consolidated
audit trail, the Commission is not proposing at this time to mandate
the format of such an identifier or how the identifier would be
generated.
The Commission requests comment on whether, and why, a unique order
identifier that would stay with the order for the life of the order is
useful or essential for an effective consolidated audit trail. In
addition, the Commission requests comment on whether there is an
alternative to a unique order identifier that would stay with the order
for the life of the order. For example, would permitting each member or
SRO that receives an order from another member or SRO to attach its own
unique identifier to an order allow the SROs to efficiently link all
events in the life an order and ensure the creation of a complete audit
trail across each market and broker-dealer that handled the order? The
Commission requests comment on the feasibility and merits of the manner
in which it proposes unique order identifiers be handled for riskless
principal transactions. The Commission also requests comment on the
feasibility and merits of requiring that a unique order identifier be
attached to an order, as well as the multiple orders that may result if
the original order is subsequently broken up into several orders, in a
manner that would permit regulators to trace the subsequent orders back
to the original single order. The Commission also requests comment on
the feasibility and merits of requiring that a unique order identifier
be attached to an order that is the result of a combination of two more
orders in a manner that would permit regulators to trace the combined
order back to its component orders. The Commission further requests
comment as to how unique order identifiers could be generated for both
electronic and manual orders, and who should be responsible for
generating them. Given the significant number of orders (including
quotations) for which information would be required to be collected and
provided to the central repository pursuant to the proposed Rule, the
Commission requests comment on the feasibility of allowing unique order
identifiers to be re-used. If unique order identifiers were to be re-
used, at what point should that be allowed? Are there any concerns with
re-use that should be addressed? Additionally, the Commission requests
comment on whether it is feasible to require unique order identifiers
if the consolidated audit trail is implemented in the proposed phased
approach? For example, is it appropriate to require that national
securities exchanges and national securities associations comply with
this requirement before their members are required to do so?
The Commission also requests comment on procedures or safeguards
market participants may wish to establish to ensure that unique order
identifiers are routed and reported accurately. Further, the Commission
requests comment on what systems modifications, if any, would be
required in order to ``tag'' every order with a unique order
identifier. Please respond to each question with specificity.
iv. Routing
The proposed Rule would require that the NMS plan require the
collection and reporting to the central repository of all material
information related to the routing of an order. Specifically, the
proposed Rule would require the reporting of the following information
each time an order is routed by the member or SRO that is doing the
routing: (1) The unique order identifier; (2) the date on which an
order was routed; (3) the exact time (in milliseconds) the order was
routed; (4) the unique identifier of the broker-dealer or national
securities exchange that routes the order; (5) the unique identifier of
the broker-dealer or national securities exchange that receives the
order; (6) the identity and nature of the department or desk to which
an order is routed if a broker-dealer routes the order internally;
\207\ and (7) the material terms of the order.\208\
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\207\ Internal routing information can be a critical element in
assessing whether a member may be disadvantaging customer orders,
either by trading ahead of customer orders, or by executing orders
as principal at prices inferior to the NBBO.
\208\ See proposed Rule 613(c)(7)(ii).
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Further, the proposed Rule would require the collection and
reporting by the SRO or member receiving an order of the following
information each time a routed order is received: (1) The unique order
identifier; (2) the date on which the order is received; (3) the time
at which the order is received (in milliseconds); (4) the unique
identifier of the broker-dealer or national securities exchange
receiving the order; (5) the unique identifier of the broker-
[[Page 32577]]
dealer or national securities exchange routing the order; and (6) the
material terms of the order.\209\
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\209\ See proposed Rule 613(c)(7)(iii).
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This information would allow regulatory staff to easily identify
each member or exchange that ``touches'' the order during its life, as
well as the dates and times at which each member or exchange receives
and reroutes the order, and any changes that may be made to the
original terms of the order along the way. The Commission preliminarily
believes that this information for orders that are routed would allow
the Commission and SROs to efficiently track an order from inception
through cancellation or execution.
The Commission requests comment as to whether such information
regarding the routing of orders is useful or necessary for an effective
consolidated audit trail. Should any additional information be included
in the consolidated audit trail relating to routing? The Commission
requests comment as to what systems modifications, if any, would be
required to provide this information. Do members currently have, or
have access to, this information? If not, what changes would need to be
made to collect this information for existing accounts for submission
to the central repository? Do commenters believe that it would be
necessary to achieve the purposes of the proposed Rule to require
information from each member or SRO that ``touches'' an order? Please
explain with specificity why or why not. Is it feasible to require
information relating to the routing of orders if the consolidated audit
trail is implemented in the proposed phased approach? For example, is
it appropriate to require that national securities exchanges and
national securities associations comply with this requirement before
their members are required to do so?
v. Modification, Cancellation, and Execution
The proposed Rule would require the NMS plan to require that
information be reported to the central repository concerning any
modifications to the material terms of an order or partial or full
order cancellations. The national securities exchange, national
securities association, or member handling the order at the time would
be required to immediately report to the central repository the
following information: (1) The unique order identifier, (2) the date
and time (in milliseconds) that an order modification or cancellation
was originated or received; (3) the identity of the person responsible
for the modification or cancellation instruction; (4) the price and
remaining size of the order, if modified; and (5) other modifications
to the material terms of the order.\210\ Information pertaining to
order modifications and cancellations would assist the Commission and
SROs in identifying all changes made to an order and the persons and
broker-dealers responsible for the changes.
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\210\ See proposed Rule 613(c)(7)(iv).
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The proposed Rule also would require the following information on
full or partial executions of orders to be collected and reported to
the central repository: (1) The unique order identifier; (2) the
execution date; (3) the time of execution (in milliseconds); (4) the
capacity of the entity executing the order (whether principal, agency,
or riskless principal); (5) the execution price; (6) the size of the
execution; (7) the unique identifier of the national securities
exchange or broker-dealer executing the order; \211\ and (8) whether
the execution was reported pursuant to an effective transaction
reporting plan or pursuant to the OPRA Plan, and the time of such
report.\212\
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\211\ Each national securities exchange and national securities
association would have its own unique identifier, as well as each
broker-dealer (member) (see supra Section III.D.1.ii.).
\212\ See proposed Rule 613(c)(7)(v).
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The Commission preliminarily believes that the required execution
information, in combination with the proposed information pertaining to
order receipt or origination, modification, or cancellation, would
provide regulators with a comprehensive, near real time view of all
stages and all participants in the life of an order. The proposed Rule
would allow the Commission and SROs to identify, for a particular
transaction, every member and national securities exchange involved in
the receipt or origination, routing, modification, and execution (or
cancellation) of the order. This order information, including the
readily accessible customer information, should help regulators
investigate suspicious trading activity in a more timely manner than
currently possible.
Additionally, the requirement to report whether and when the
execution of the order was reported to the consolidated tape \213\
should allow regulators to more efficiently evaluate certain trading
activity. For example, trading patterns of reported and unreported
transactions may cause the staff of an SRO or the Commission to make
further inquiry into the nature of the trading to determine whether the
public was receiving accurate and timely information regarding
executions and that market participants were continuing to comply with
the trade reporting obligations under SRO rules. Similarly, patterns of
reported and unreported transactions could be indicia of market abuse,
including failure to obtain best execution for customer orders or
possible market manipulation. Being able to more efficiently compare
the consolidated order execution data with the trades reported to the
consolidated tape could thus be an important component of overall
surveillance activity.
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\213\ Id. See also infra Section III.F.1. for a discussion of
the requirement in proposed Rule 613(e)(5) that the NMS plan require
the central repository to receive and retain on a current and
continuing basis (i) the national best bid and national best offer
for each NMS security, (ii) transaction reports reported pursuant to
a transaction reporting plan filed with the Commission pursuant to,
and meeting the requirements of, Rule 601 of Regulation NMS, and
(iii) last sale reports reported pursuant to the OPRA Plan.
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As discussed above, the Commission recognizes that the execution of
orders often is complex.\214\ For example, a customer order may be
executed on a riskless principal basis. When a member receives a
customer order, rather then sending the customer order as an agency
order to an exchange or other marketplace for execution, the member
creates an order for its proprietary account that it sends to an
exchange or other marketplace to be executed. Once an execution occurs
in the proprietary account, the member would then execute the customer
order against its proprietary account. This process can be complicated
by the member receiving and handling more than one customer order at a
time, and creating one or more proprietary orders to send to one or
more markets, and the manner in which the member allocates executions
from its proprietary account among the customer orders. Each
proprietary order would have a unique order identifier that is
different from, and not linked to, the unique order identifier for the
original customer order. How should the reporting to the central
repository of the execution of the proprietary orders and the customer
order be handled? As noted above, the Commission envisions that the
manner in which the execution of the customer order would be ``linked''
with one (or more) of the proprietary order(s) would be through the
inclusion of the unique order identifier for the contra-side order(s)
on the report of the execution of the customer order sent to
[[Page 32578]]
the central repository.\215\ Is this practical? Is there another method
by which to link the execution of the customer order to the proprietary
orders? Is it necessary to do so to achieve the purposes of the
consolidated audit trail?
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\214\ See supra notes 205-206 and accompanying text.
\215\ See supra note 206 and accompanying text.
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The Commission requests comment on whether the information proposed
to be collected and reported would be sufficient to create a complete
and accurate audit trail. Is there additional information that should
be collected and reported? If yes, please describe the information and
the value its collection and reporting would add to the consolidated
audit trail.
2. Information To Be Collected Other Than in Real Time
While the majority of order and execution information would be
required to be transmitted to the central repository on a real time
basis, the Commission recognizes that this may not be practical or
feasible for all information because the information may not be known
at the time of the reportable event.\216\ Thus, the Commission is
proposing that certain information be transmitted to the central
repository promptly after the national securities exchange, national
securities association, or member receives the information, but in no
instance later than midnight of the day that the reportable event
occurs or the national securities exchange, national securities
association, or member receives such information.\217\ The Commission
preliminarily believes that this proposed time frame would provide
sufficient time for an exchange, association, or a member to obtain the
information required to be reported while still allowing regulators to
access the information for regulatory purposes on a more timely basis
than today.
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\216\ For example, a member may receive an order during the day
from an advisory customer but not know to which sub-accounts to
allocate execution of the order until later in the day.
\217\ See proposed Rule 613(c)(4).
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Each national securities exchange, national securities association
and their members would be required to report the account number for
any subaccounts to which an execution is allocated.\218\ By requiring
that this data be included in the consolidated audit trail, regulators
would be able to more easily identify the ``ultimate'' customer for the
trade. The Commission preliminarily believes that it would be useful to
know the account number as well as the required information on the
beneficial owner. For example, a person or groups of persons could
trade through a single account or numerous accounts. Because individual
traders may use multiple accounts at multiple broker-dealers, being
able to identify the beneficial owner of the underlying accounts aids
in the identification and investigation of suspicious trading activity.
Similarly, traders may seek to hide manipulative activity from
regulatory oversight by trading anonymously through omnibus accounts.
In those instances, linking the trade to the individual trader requires
the market center to be able to identify both the accounts trading and
the beneficial owner or owners of those accounts to determine what
person or group of persons is directing the specific trades at issue.
Requiring the identity of the ultimate customer electronically to be
attached to each order would make this information easily accessible
and searchable and thus would greatly improve the usefulness of audit
trail information for purposes of effective enforcement and cross-
market surveillance.
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\218\ See proposed Rule 613(c)(7)(vi)(A).
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Each national securities exchange, national securities association
and their members also would be required to report the unique
identifier of the clearing broker or prime broker for the transaction,
if applicable, and the unique order identifier of any contra-side
order.\219\ Finally, if the execution is cancelled, a cancelled trade
indicator would be required to be reported. In addition, the proposed
Rule also would require the reporting of any special settlement terms
for the execution, if applicable; short sale borrower information and
identifier; and the amount of a commission, if any, paid by the
customer, and the unique identifier of the broker-dealer(s) to whom the
commission is paid.\220\
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\219\ See proposed Rule 613(c)(7)(vi)(B) and (C).
\220\ See proposed Rule 613(c)(7)(vi)(D), (E), and (F).
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Broker-dealers have a duty of best execution.\221\ Since
commissions can be charged either explicitly through a separate fee or
implicitly in the transaction price, the lack of easily accessible
commission fee data alongside transaction price data may make it hard
to identify the ``all-in'' price of execution and, thus, hard to
determine whether the obligation to seek best execution was met.\222\
In addition, broker-dealers also must comply with just and equitable
principles of trade under NASD rules that require them to charge fair
commissions and mark-ups (mark-downs), and the lack of easily
accessible commission fee data may make it hard to determine whether
just and equitable principles of trade have been observed.\223\ Also,
FINRA rules prohibit certain quid pro quo arrangements in the
distribution of IPOs.\224\
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\221\ A broker-dealer has a legal duty to seek to obtain best
execution of customer orders. See, e.g., Newton v. Merrill, Lynch,
Pierce, Fenner & Smith, Inc., 135 F.3d 266, 269-70, 274 (3d Cir.),
cert. denied, 525 U.S. 811 (1998); Certain Market Making Activities
on Nasdaq, Securities Exchange Act Release No. 40900 (Jan. 11, 1999)
(settled case) (citing Sinclair v. SEC, 444 F.2d 399 (2d Cir. 1971);
Arleen Hughes, 27 SEC 629, 636 (1948), aff'd sub nom. Hughes v. SEC,
174 F.2d 969 (D.C. Cir. 1949)). See also Order Execution
Obligations, Securities Exchange Act Release No. 37619A (Sept. 6,
1996), 61 FR 48290 (Sept. 12, 1996) (``Order Handling Rules
Release''). A broker-dealer's duty of best execution derives from
common law agency principles and fiduciary obligations, and is
incorporated in SRO rules and, through judicial and Commission
decisions, the antifraud provisions of the federal securities laws.
See Order Handling Rules Release, 61 FR at 48322. See also Newton,
135 F.3d at 270. The duty of best execution requires broker-dealers
to execute customers' trades at the most favorable terms reasonably
available under the circumstances, i.e., at the best reasonably
available price. Newton, 135 F.3d at 270. Newton also noted certain
factors relevant to best execution--order size, trading
characteristics of the security, speed of execution, clearing costs,
and the cost and difficulty of executing an order in a particular
market. Id. at 270 n.2 (citing Payment for Order Flow, Exchange Act
Release No. 33026 (Oct. 6, 1993), 58 FR 52934, 52937-38 (Oct. 13,
1993) (Proposed Rules)). See In re E.F. Hutton & Co., Securities
Exchange Act Release No. 25887 (July 6, 1988). See also Securities
Exchange Act Release No. 34902 (October 27, 1994), 59 FR 55006,
55008-55009 (November 2, 1994) (``Approval of Payment for Order Flow
Final Rules''). See also Securities Exchange Act Release No. 51808
(June 9, 2005), 70 FR 37496 (June 29, 2005) (``NMS Adopting
Release''), at 37537 (discussing the duty of best execution).
\222\ The term ``all-in'' price is intended to capture the total
costs for executing a trade.
\223\ See FINRA Rule 2010 and IM-2440-1.
\224\ See FINRA Rule 5130. The Rule ensures that: (1) FINRA
members make bona fide public offerings of securities at the
offering price; (2) members do not withhold securities in a public
offering for their own benefit or use such securities to reward
persons who are in a position to direct future business to members;
and (3) industry insiders, including FINRA members and their
associated persons, do not take advantage of their insider position
to purchase ``new issues'' for their own benefit at the expense of
public customers. For example, information on commissions could help
detect a transaction in the secondary market between an underwriter
and an investor at an excessively high commission rate that is a
``quid pro quo'' for the underwriter allocating shares in a ``hot''
IPO to the investor.
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The Commission requests comment on the usefulness and necessity of
requiring the reporting of each of these items of information to
achieve the stated objectives of the consolidated audit trail. Are
there practical difficulties associated with providing this information
as proposed? Is there additional information that would be useful or
necessary in this regard? For example, the proposed Rule would require
the reporting of a cancelled trade indicator, for executions that are
cancelled. Should the proposed Rule
[[Page 32579]]
require separate identification of trades that are broken pursuant to
the rules of the applicable SRO at the request of one party to a
transaction or upon the SRO's own motion, and trades that are cancelled
by mutual agreement of the parties? Why or why not? The Commission also
requests comment on whether the proposed requirement to report the
identity of the clearing broker would provide sufficient information on
``give-up'' arrangements,\225\ or whether additional information should
be required to be reported.
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\225\ In a typical give-up arrangement, a broker-dealer that is
not a member of an exchange (Broker-dealer A) may route the order to
another broker-dealer that is a member of an exchange (Broker-dealer
B) for execution on that exchange. If Broker-dealer B is not also a
clearing member of the exchange, it may ``give-up'' the execution of
that order to another broker-dealer that is a clearing member of
that exchange (Broker-dealer C). Further, there may be a
corresponding ``flip'' of the trade from Broker-dealer C's account
to the account of the broker-dealer that is the clearing firm for
Broker-dealer A.
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The Commission requests comment on the proposed time frame for
reporting of this information. The Commission is proposing that the
information not required to be reported in real time be reported
promptly after receipt, but in no event later than midnight on the day
the reportable event occurs or the exchange, association, or member
receives the information. While one of the objectives of the proposed
Rule is to collect data on a real time basis, the Commission
understands that certain information may not be available at the time
of the reportable event (e.g., the execution or cancellation). The
Commission, however, believes such information should be provided
promptly after receipt, meaning as soon as possible given the
capabilities of a market participant's systems. While the Commission is
proposing that the information be reported promptly, the proposed Rule
also would provide an objective time limit for providing the
information--no later than midnight on the day the event occurs or the
information is received by the exchange, association, or member. Is the
proposed time frame reasonable with respect to the information that
would be required to be reported? Should the proposed Rule only require
that information be reported promptly after receipt? How should
promptly be measured? Alternatively, should the proposed Rule only
require that information not available at the time the reportable event
occurs be reported no later than midnight on the day the information
was received? How would this standard impact the usefulness of the
consolidated audit trail?
E. Clock Synchronization
The Commission believes that clock synchronization is necessary to
ensure an accurate audit trail, given the number of market participants
with internal order handling and trading systems that would be
reporting information to the central repository. Therefore, proposed
Rule 613(d) would provide that the NMS plan filed with the Commission
include a requirement that each national securities exchange and
national securities association, and their members, synchronize their
business clocks that are used for the purposes of recording the date
and time of any event that must be reported under the proposed Rule.
The proposed Rule would require each exchange, FINRA, and their members
to synchronize their clocks to the time maintained by the National
Institute of Standards and Technology (``NIST''), consistent with
industry standards.\226\ Exchanges, associations, and the members would
be required to synchronize their business clocks in accordance with
these requirements within four months after effectiveness of the NMS
plan.\227\
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\226\ See proposed Rule 613(d)(1).
\227\ See proposed Rule 613(a)(3)(ii).
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The Commission is not proposing to set a standard within which the
clocks must be synchronized to the NIST (e.g., to within one second of
the NIST clock), in recognition of how quickly technology can improve
and increase the speed at which orders are handled and executed.
Rather, the Commission is proposing that the clocks be synchronized
``consistent with industry standards.'' The exchanges and FINRA would
be able, however, to set a limit in the NMS plan to be filed with the
Commission. Also, in recognition of the pace at which technology
improves, the proposed Rule provides that the NMS plan shall require
each national securities exchange, national securities association, and
its respective members to annually evaluate the actual synchronization
standard adopted to consider whether it should be shortened, consistent
with changes in industry standards.\228\ When engaging in this annual
evaluation, exchanges, associations, and members could take into
account the feasibility of shortening the time standard, and whether
shortening the standard would allow for the conveyance of additional
meaningful information to the consolidated audit trail.
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\228\ See proposed Rule 613(d)(2).
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The Commission requests comment on whether this approach is
practical and would provide for sufficient flexibility in determining
how closely to synchronize clocks. Is the proposed Rule's requirement
that each exchange, association, and member synchronize its clocks in
accordance with the time maintained by NIST reasonable? To what extent
do SROs and their members currently synchronize clocks? Please answer
with specificity. Would synchronization as proposed require significant
systems modifications on behalf of national securities exchanges,
national securities association, or their respective members? Is it
reasonable to require clocks to be synchronized with the time
maintained by NIST within a time frame that is ``consistent with
industry standards''? Is there another standard that should be used by
the Commission? The Commission also requests comment on the feasibility
of requiring the exchanges, FINRA, and their members to comply with
these requirements within four months of effectiveness of the NMS plan.
F. Central Repository
The proposed Rule would require that the NMS plan provide for the
creation and maintenance of a central repository, which would be a
facility of each exchange and FINRA.\229\ The central repository would
be jointly owned and operated by the exchanges and FINRA, and the NMS
plan would be required to provide, without limitation, the Commission
and SROs with access to, and use of, the data reported to and
consolidated by the central repository for the purpose of performing
their respective regulatory and oversight responsibilities pursuant to
the federal securities laws, rules, and regulations. Each of the
exchanges and FINRA would be a sponsor of the plan,\230\ and as such
would be responsible for selecting a plan processor to operate the
central repository.\231\
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\229\ See proposed Rule 613(e)(1).
\230\ See supra note 173 for a definition of a plan sponsor in
Rule 600(a)(70) of Regulation NMS, 17 CFR 242.600(a)(70).
\231\ See infra Section III.I. for a definition and discussion
of the plan processor.
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The Commission requests comment on the need for a central
repository to receive and retain the consolidated audit trail
information. Are there alternatives to creating a central repository
for the receipt of order audit trail information? The Commission also
requests comment on whether it is practical or appropriate to require
the exchanges and FINRA to jointly own and operate the central
repository.
[[Page 32580]]
1. Responsibilities of Central Repository To Collect, Consolidate, and
Retain Information
The central repository would be responsible for the receipt,
consolidation, and retention of all data submitted by the national
securities exchanges, national securities associations and their
members pursuant to the proposed Rule and the NMS plan.\232\ Further,
the central repository would be required to collect from the central
processors and retain on a current and continuous basis the NBBO for
each NMS security, transaction reports reported pursuant to an
effective transaction reporting plan filed with the Commission pursuant
to, and meeting the requirements of, Rule 601 of Regulation NMS, and
last sale reports reported pursuant to the OPRA Plan filed with the
Commission pursuant to, and meeting the requirements of, Rule 608 of
Regulation NMS.\233\ The central repository would be required to
maintain this NBBO and transaction data in a format compatible with the
order and event information reported pursuant to the proposed Rule.
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\232\ See proposed Rule 613(e)(1).
\233\ See proposed Rule 613(e)(5). The central repository would
be required to retain the information collected pursuant to
subparagraph (c)(7) and (e)(5) of the proposed Rule in a convenient
and usable standard electronic data format that is directly
available and searchable electronically without any manual
intervention for a period of not less than five years. The
information would be required to be available immediately, or if
immediate availability could not reasonably and practically be
achieved, any search query would be required to begin operating on
the data not later than one hour after the search query is made. See
proposed Rule 613(e)(6).
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This requirement is intended to allow SRO and Commission staff to
easily search across order, NBBO, and transaction databases. The
Commission preliminarily believes that having the NBBO information in a
format compatible with the order audit trail information would be
useful for enforcing compliance with federal securities laws, rules and
regulations. The NBBO is used by regulators to evaluate members for
compliance with numerous regulatory requirements, such as the duty of
best execution or Rule 611 of Regulation NMS.\234\ Regulators would be
able to compare order execution information to the NBBO information on
a more timely basis because the order and execution information would
be available on a real time basis and all of the information would be
available in a compatible format in the same database. The SROs also
may enjoy economies of scale by adopting standard cross-market
surveillance parameters for these types of violations. This information
also would be available to the Commission to assist in its oversight
efforts.
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\234\ See Rule 611 of Regulation NMS, 17 CFR 242.611. See also
ISE Rule 1901, NYSE Arca 6.94, and Phlx Rule 1084.
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The Commission also preliminarily believes that requiring the
central repository to collect and retain in its database the
transaction information in a format compatible with the order execution
information would aid in monitoring for certain market manipulations.
As discussed above, the proposed Rule would require that each report of
the execution (in whole or in part) of an order sent to the central
repository include a notation as to whether the execution was reported
to the consolidated tape pursuant to an effective transaction reporting
plan or the OPRA Plan.\235\ This requirement should allow regulators to
more efficiently evaluate certain trading activity. For example,
trading patterns of reported and unreported trades may cause the staff
of an SRO to make further inquiry into the nature of the trading to
determine whether the public was receiving accurate and timely
information regarding executions and that market participants were
continuing to comply with the trade reporting obligations under SRO
rules. Similarly, patterns of reported and unreported transactions
could be indicia of market abuse, including failure to obtain best
execution for customer orders or possible market manipulation. Being
able to more efficiently compare the consolidated order execution data
with the trades reported to the consolidated tape could thus be an
important component of overall surveillance activity.
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\235\ See supra Section III.D.1.v.
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The Commission requests comment on the usefulness or necessity of
requiring the central repository to collect and retain in a format
compatible with the order audit trail information the NBBO and
transaction report information to help achieve the stated objectives of
the consolidated audit trail. Do commenters believe that it is
important for achieving the purposes of the consolidated audit trail?
If so, why? If not, why not? What are the advantages and disadvantages
of maintaining transaction information separately from order and
execution data included in the consolidated audit trail? Should the
transaction information be included in the consolidated audit trail
report? The Commission requests comment on whether the requirement that
the transaction and NBBO information be maintained in a format
compatible with the order information is practical. Would this
requirement achieve the goal of helping SRO and Commission staff
conducts searches and run surveillances across databases?
The Commission has recently required that issuers report certain
data in interactive data format such as XBRL.\236\ This proposal does
not specify any particular or required data format, but allows the SROs
to select a data format. Should the Commission require that the data be
transmitted or stored in any particular format? What are the relative
merits of flat data files, relational data files, and interactive data
files? What other formats should be considered? In what format can the
SROs and their members efficiently transmit data? In what format would
the data required in the proposal be most easily accessed?
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\236\ See Securities Act Release No. 9002 (January 30, 2009), 74
FR 6776 (February 10, 2009) (Interactive Data to Improve Financial
Reporting adopting release) (File No. S7-11-08).
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The proposed Rule would require the NMS plan to require the central
repository to retain the information collected pursuant to subparagraph
(c)(7) and (e)(5) of the proposed Rule in a convenient and usable
standard electronic data format that is directly available and
searchable electronically without any manual intervention for a period
of not less than five years. The information would be required to be
available immediately, or if immediate availability could not
reasonably and practically be achieved, any search query would be
required to begin operating on the data not later than one hour after
the search query is made.\237\
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\237\ See proposed Rule 613(e)(6).
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The Commission preliminarily believes that the information (or the
results of a query searching the information) should generally be
available immediately. However, the Commission recognizes that the
results of an electronic search query may not be immediately available
because, for instance, the system must check an extremely large number
of records to answer the query or the system may need to retrieve
records from electronically archived data. In the case of archived
data, the Commission preliminarily proposes requiring that the search
query would need to begin operating on the data not later than one hour
after the query is made. The Commission requests comment as to whether
one hour would be reasonable amount of time to allow for accessing
archived data. Under current technological limitations, how long should
it take to access, in an electronic query with no manual intervention,
archived data of the type to be held by
[[Page 32581]]
the central repository? The Commission also requests comment on whether
it should mandate a time standard, such as one hour, in the proposed
Rule. Further, the Commission requests comment on whether the central
repository should be required to retain this information for longer or
shorter than five years. The Commission also requests comment on the
cost impact of these proposed record retention requirements. For
example, could comparable functionality be obtained at lower cost with
a different standard (for example, what would be the cost comparison
for one hour versus two hours)?
2. Access to Central Repository and Consolidated Audit Trail
Information and Confidentiality of Consolidated Audit Trail Information
Each national securities exchange and national securities
association, as well as the Commission, would have access to the
central repository for purposes of performing its respective regulatory
and oversight responsibilities pursuant to the federal securities laws,
rules, and regulations. Such access would include access to all systems
of the central repository, and access to and use of the data reported
to and consolidated by the central repository.\238\ The proposed Rule
also would require that the NMS plan provide that such access to and
use of such data by each exchange, association, and the Commission for
the purpose of performing its regulatory and oversight responsibilities
pursuant to the federal securities laws, rules, and regulations shall
not be limited.\239\ In addition, the proposed Rule would require that
the NMS plan include a provision requiring the creation and maintenance
by the central repository of a method of access to the consolidated
data.\240\ This method of access would be required to be designed to
include search and reporting functions to optimize the use of the
consolidated data.
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\238\ See proposed Rule 613(e)(2).
\239\ Id.
\240\ See proposed Rule 613(e)(3).
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The Commission's access to the central repository, and access to
and use of the data maintained by the central repository, for purposes
of performing the Commission's responsibilities under the federal
securities laws, rules, and regulations could not be limited in any
way.\241\ The Commission requests comment as to whether the proposed
Rule as proposed would accomplish this objective? If not, why not? If
not, please provide comment as to an alternative or additional way to
accomplish this objective. The Commission also requests comment on the
advantages or disadvantages of Commission ownership or co-ownership of
the data maintained by the central repository.
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\241\ As noted above, the central repository would be a facility
of each exchange and FINRA (see supra note 229 and accompanying
text), and as such, subject to the Commission's recordkeeping and
inspection authority. See, e.g., Section 17 of the Exchange Act, 17
U.S.C. 78q. Further, any amendment to the NMS plan would be filed
with the Commission pursuant to Rule 608 of Regulation NMS, and
would not become effective unless approved by the Commission or
otherwise as permitted in accordance with the requirements of Rule
608. See proposed Rule 613(a)(5), and Rule 608(a) and (b) of
Regulation NMS, 17 CFR 242.608(a) and (b).
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As discussed above, the proposed Rule would require the reporting
of customer information, as well as information about ``live'' orders,
to the central repository on a real time basis. The Commission
recognizes the sensitivity of this information, and believes that
maintaining the confidentiality of, and limiting the use of, the data
is essential. Without such protections, broker-dealers and the
investing public could be at risk for security breaches that would
potentially have a detrimental impact on their financial condition, as
well as their trading activity and the markets. The consolidated data
also would include information about members' trading activities on
competitors' markets. The Commission therefore is proposing several
requirements designed to limit access to, and help assure
confidentiality and proper use of, the information.
As noted above, the proposed Rule would limit the use of the
consolidated data by the SROs for purposes of performing their
respective regulatory and oversight responsibilities pursuant to the
federal securities laws, rules, and regulations.\242\ This proposed
restriction would not prevent any SRO from using the data that it
individually collects and provides to the central repository pursuant
to the proposed Rule for other purposes as permitted by applicable law,
rule or regulation.
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\242\ See proposed Rules 613(e)(2). See also proposed Rule
613(e)(4)(i) (requiring in part that the NMS plan include a
provision requiring all plan sponsors and their employees to agree
not to use the consolidated data for any purpose other than
surveillance and regulatory purposes).
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The Commission requests comment as to whether access to the
consolidated audit trail information should be limited to the SROs and
the Commission, or whether there should be other access allowed. For
example, should SROs or the central repository be allowed to make the
data available to third parties, such as for academic research? If so,
should the data be permitted to be sold to help offset costs? By SROs?
By the central repository? If so, should there be set parameters? If
the data were made available to third parties, what protections should
be put in place to ensure the confidentiality of the data? Are there
particular data elements that are more sensitive and should not be sold
to help ensure the privacy of any individual and proprietary
information? Are there particular data elements that would pose fewer
concerns if released on a significant time lag? How long would such a
time lag need to be? What other concerns might arise from the use of
the data for non-regulatory purposes? Would use of the data provide
certain market participants with undue information advantages over
other market participants, increasing informational asymmetry in the
markets? Would the provision of market data to third parties affect the
willingness of market participants to trade in the U.S. markets? On the
other hand, would enhanced surveillance of the markets as a result of
the consolidated audit trail attract additional trading volume to the
U.S. markets? What would be the implications, if any, under the
financial privacy provisions of the Gramm-Leach-Bliley Act? \243\ The
Commission also requests comment as to whether, and to what extent,
other regulators, such as the Commodity Futures Trading Commission,
should have access to the data? For instance, to what extent do
commenters believe it would be beneficial for the Commission to work
with other regulators to collectively share information each regulator
has with respect to products and trading activity under its
jurisdiction, to help the Commission and other regulators carry out
their respective oversight of products and trading activity within
their own jurisdiction? Would such sharing of information help the
Commission better understand the impact of trading in other markets on
trading activity and products within the Commission's jurisdiction?
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\243\ 15 U.S.C. 6801-6809.
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The Commission also requests comment on the feasibility of, and
need for, a method of access to the consolidated data that includes
search and reporting functions. In addition, the Commission requests
comment as to whether, in addition to requiring the central repository
to provide a method of access, the central repository should be
required to bear the cost of making available the raw order data
received by the central repository, for purposes of using that data to
perform regulatory functions. Commenters are requested to
[[Page 32582]]
provide cost estimates for the provision of this data by the central
repository to the SROs and the Commission.
Proposed Rule 613(e)(4)(i) also would require that the NMS plan
include policies and procedures, including standards, to be used by the
plan processor to ensure the security and confidentiality of all
information submitted to, and maintained by, the central repository.
The plan sponsors, and employees of the plan sponsors and central
repository, would be required to agree to use appropriate safeguards to
ensure the confidentiality of such data, and not to use such data for
other than for surveillance regulatory purposes.\244\ The Commission is
not proposing to mandate the content or format of the policies and
procedures and standards that would be required. Rather, the Commission
believes that the SROs themselves are in the best position to determine
how best to implement this requirement.
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\244\ See proposed Rule 613(e)(4)(i). However, a plan sponsor
would be permitted to use the data that it submits to the central
repository for regulatory, surveillance, commercial, or other
purposes as otherwise permitted by applicable law, rule or
regulation. Id.
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The Commission requests comment generally on the issue of
appropriate safeguards to be put in place by the SROs and the central
repository to help ensure confidentiality. Are there specific
safeguards that the SROs and the central repository could use to ensure
the confidentiality and appropriate usage of the data collected and
submitted pursuant to the proposed Rule? For example, should the
proposed Rule require that SROs put in place specific information
barriers or other protections to help ensure that data is used only for
regulatory purposes? Should there be an audit trail of the SROs'
personnel access to, and use of, information in the central repository
to help monitor for compliance with appropriate usage of the data?
Should the requirement that the NMS plan include policies and
procedures to be used by the plan processor to ensure the security and
confidentiality of information submitted to, and maintained by, the
central repository be expanded to include the content of any searches
or queries performed by the SROs or the Commission on the data? What
should be required? Please be specific in your answer.
The Commission would establish appropriate protections within the
agency to help ensure the confidentiality of the records.
3. Reliability of Data Collected and Consolidated
An audit trail is only as reliable as the data used to create it.
The Commission believes that it is critical to the integrity of the
consolidated audit trail that the data submitted by the national
securities exchanges, national securities associations and their
members be submitted in a timely manner, and be accurate and complete.
Proposed Rule 613(e)(4)(ii) therefore would require that the NMS plan
include policies and procedures, including standards, for the plan
processor to use to help ensure the integrity of the information
submitted to the central repository. Specifically, the policies and
procedures would be required to be designed to help ensure the
timeliness, accuracy, and completeness of the data provided to the
central repository by the SROs and their members. The Commission
expects that these policies and procedures would include the creation
of certain validation parameters that would need to be met before data
would be accepted into the central repository.
The proposed Rule also would require that the NMS plan include
policies and procedures, including standards, governing how and when
the plan processor should reject data provided to the central
repository that does not meet these validation parameters. Further, the
proposed Rule would require the NMS plan to include policies and
procedures that would govern how to re-transmit data that was rejected
once it has been corrected, and how to help ensure that information is
being resubmitted.\245\ The Commission expects that re-transmitted data
would also be subject to the validation parameters to assure that the
initial problem(s) with the data has been corrected.
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\245\ See proposed Rule 613(e)(4)(iii).
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In addition, the proposed Rule would require that the NMS plan
include policies and procedures to ensure the accuracy of the
consolidation of the data by the plan processor provided to the central
repository. Again, the Commission notes that it is not proposing to
mandate the form and content of such policies and procedures. Rather,
it believes the SROs would be in a better position to determine how
best to implement this requirement. The Commission requests comment on
these proposed requirements. Is this approach practical to ensure the
integrity of the data? Are there any alternative methods that would
achieve the same purpose that are preferable? How much latency would
result from a validation procedure?
As noted above, the Commission believes it is critical to the
integrity of the consolidated audit trail that data submitted to the
central repository be submitted in a timely manner and be accurate and
complete. To support this objective, as discussed below in Sections
III.H.1 and III.H.2, the proposed Rule also would require the NMS plan
to include mechanisms to ensure compliance by the plan sponsors and
their members with the requirements of the plan.\246\ The purpose of
the provisions, with respect to SRO compliance, is to require the SROs
themselves to implement a method to help ensure compliance with the NMS
plan, as is required by Rule 608 of Regulation NMS. Although the
Commission is not proposing to mandate the format of the mechanism, the
Commission preliminarily believes that it could include the imposition
of penalties on an SRO in the event an SRO failed to comply with any
provision of the NMS plan. Further, the Commission preliminarily
believes that the mechanism to help ensure compliance by members could
include the imposition of fines on a member, subject to the rules of
the SRO of which it is a member, in the event a member failed to comply
with the requirements of the NMS plan or the SRO's rules.
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\246\ See proposed Rule 613(h)(3) and Rule 613(g)(4).
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G. Surveillance
Proposed Rule 613(f) would require each national securities
exchange and national securities association subject to the proposed
Rule to develop and implement a surveillance system, or enhance
existing surveillance systems, reasonably designed to make use of the
consolidated information contained in the consolidated audit trail. The
proposed Rule would require each national securities exchange and
national securities association to implement such new or enhanced
surveillance system within fourteen months after effectiveness of the
NMS plan.\247\ Currently, SROs are required to surveil members' trading
activity for compliance with federal securities laws, rules, and
regulations, such as rules relating to front running, trading ahead,
market manipulation, and quote rule
[[Page 32583]]
violations, as well as other Commission and SRO rules. The Commission
understands that although SROs carry out certain surveillances in real
time, such as for looking for pricing anomalies or other indicators of
erroneous transactions, most surveillance currently is not done on a
real time basis. The Commission preliminarily believes the systems that
carry out this surveillance should be updated, or new systems should be
created, to make use of the consolidated audit trail information that
would be generated and maintained by the central repository, otherwise
the purpose of requiring a consolidated audit trail would not be
achieved.
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\247\ See proposed Rule 613(a)(3)(iv). The SROs would be
required to begin reporting information to the central repository
within twelve months after effectiveness of the NMS plan. The
Commission is proposing to allow SROs two additional months (for a
total of fourteen months) to update their surveillance systems to
allow for testing of new surveillances for some period of time after
the SROs begin providing information. The Commission requests
comment on this time period. Should it be longer? Shorter? If so,
why?
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The Commission generally requests comment on this proposed
requirement, as well as the proposed timing for compliance. To what
extent do SROs currently conduct surveillance of trading on their
markets on a real time basis? To what extent could SROs make effective
use of the proposed consolidated information to enhance or update their
existing surveillance and regulation? How would SROs be able to enhance
or change their existing surveillance and regulation to make use of the
proposed consolidated information? Would the benefits of surveillance
that the SROs would be able to undertake be justified by the costs of
providing information to the central repository on a real time basis?
Under the proposed Rule, national securities exchanges and national
securities associations would be required to implement or enhance their
surveillance systems prior to their members being required to provide
information pursuant to the proposed Rule. Do commenters believe that
surveillance systems should be in place in advance of member compliance
or should these requirements happen simultaneously, or otherwise?
The Commission is not proposing at this time to require coordinated
surveillance across exchanges and FINRA. Rather, the Commission intends
that each SRO would be responsible for surveillance of its own market
and its own members using the consolidated audit trail information. The
Commission would, however, encourage any coordinated surveillance
efforts by the SROs, such as through a plan approved pursuant to Rule
17d-2 under the Exchange Act,\248\ or a regulatory services agreement
among one or more SROs. The Commission requests comment on whether it
should undertake to require coordinated surveillance.
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\248\ 17 CFR 240.17d-2. For example, the exchanges have entered
into an agreement for the allocation of regulatory responsibilities
pursuant to Rule 17d-2 under the Exchange Act concerning the
surveillance, investigation, and enforcement of insider trading
rules pertaining to members of the NYSE and FINRA who are also
members of at least one of the other participating SROs. See
Securities Exchange Act Release No. 58806 (File No. 4-566) (October
17, 2008), 73 FR 63216 (October 23, 2008).
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H. Compliance With the NMS Plan
1. Exchanges and Associations
Any failure by a national securities exchange or national
securities association that is a sponsor of the NMS plan to comply with
the requirements of the NMS plan would undermine the effectiveness of
the proposed Rule. Therefore, the Commission would consider full
compliance by these entities with the NMS plan of the utmost
importance. To this end, the proposed Rule would provide that each
national securities exchange and national securities association shall
comply with the provisions of the NMS plan of which it is a sponsor
submitted pursuant to the proposed Rule and approved by the
Commission.\249\ In addition, the proposed Rule would provide that any
failure by a national securities exchange or national securities
association to comply with the provisions of the NMS plan of which it
is a sponsor could be considered a violation of the proposed Rule.\250\
For example, a failure to provide required information to the central
repository, a failure to develop and implement a surveillance system or
enhance existing surveillance systems reasonably designed to make use
of the consolidated data in the central repository, or any limitation
on the ability of an SRO or the Commission to access and use the data
maintained by the central repository for regulatory purposes would
violate the proposed Rule. The Commission recognizes that its staff,
and the SRO staff, may have to undertake certain technical actions to
access the data, such as arranging for a live feed, querying the
system, or upgrading systems to be able to receive the data. The
Commission preliminarily would not view having to take such technical
actions, by themselves, as a limitation. The Commission notes that the
proposed Rule would require the central repository to maintain the data
in a convenient and usable standard electronic data format that is
directly available and searchable electronically without any manual
intervention for a period of not less than five years. The information
would be required to be available immediately, or if immediate
availability could not reasonably and practically be achieved, any
search query would be required to begin operating on the data not later
than one hour after the search query is made.\251\ The Commission
requests comment on whether other types of technical actions should not
be viewed as an impermissible limitation on access. The Commission
further notes that Rule 608(c) under the Exchange Act provides that
``[e]ach self-regulatory organization shall comply with the terms of
any effective national market system plan of which it is a sponsor or a
participant.'' \252\ Thus, under this proposed Rule, the Commission may
take any action authorized under the Exchange Act to discipline
national securities exchanges and national securities associations for
failure to comply with a rule under the Exchange Act.
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\249\ See proposed Rule 613(h)(1)
\250\ See proposed Rule 613(h)(2).
\251\ See proposed Rule 613(e)(6) and supra note 237 and
accompanying text.
\252\ 17 CFR 242.608(c).
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The proposed Rule also would require that the NMS plan include a
mechanism to ensure compliance by the sponsors with the requirements of
the plan.\253\ The purpose of this provision is to require the SROs
themselves to implement a method to help ensure compliance with the NMS
plan, as is required by Rule 608 of Regulation NMS. Although the
Commission is not proposing to mandate the format of the mechanism, the
Commission preliminarily believes that it could include the imposition
of penalties on an SRO in the event an SRO failed to comply with any
provision of the NMS plan. The Commission request comments on the types
of sanctions or penalties that would be appropriate for the plan
sponsors to levy for failure of an SRO to comply with the terms of the
NMS plan.
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\253\ See proposed Rule 613(h)(3).
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2. Members
Any failure by a member of a national securities exchange or
national securities association that is a sponsor of the NMS plan to
collect and provide to the central repository the required audit trail
information also would undermine the effectiveness of the proposed
Rule. Therefore, the Commission would consider full compliance by these
entities with the NMS plan of the utmost importance.
To implement the proposed requirement that the NMS plan require the
submission of certain information to the central repository by the
members of the exchange and association sponsors of the plan, each
exchange and
[[Page 32584]]
association would be required to file with the Commission pursuant to
Section 19(b)(2) of the Exchange Act \254\ and Rule 19b-4
thereunder,\255\ a proposed rule change to require its members to
comply with the requirements of the proposed Rule and the NMS
plan.\256\ The SROs would be required to file these proposed rule
changes by 120 days after approval of the proposed Rule. The Commission
preliminarily believes that this proposed time frame would provide the
SROs sufficient time to file their proposed rule changes after the NMS
plan has been approved,\257\ as the SRO rule filings would be
substantially based on the content of the NMS plan.
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\254\ 15 U.S.C. 78s(b)(2).
\255\ 17 CFR 240.19b-4.
\256\ See proposed Rule 613(g)(1). This provision in the
proposed Rule echoes the requirement contained in Rule 608 that
provides ``each self-regulatory organization also shall, absent
reasonable justification or excuse, enforce compliance with any such
plan by its members and persons associated with its members,'' 17
CFR 242.608(c).
\257\ The proposed Rule would require that the NMS plan be filed
within 90 days of approval of the proposed Rule. See proposed Rule
613(a)(1).
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Further, the proposed Rule would directly require each member to
(1) collect and submit to the central repository the information
required by the Rule, and (2) comply with the clock synchronization
requirements of the proposed Rule.\258\ In addition, the proposed Rule
would require that the NMS plan include a provision that by subscribing
to and submitting the plan to the Commission, each exchange and
association that is a sponsor to the plan agrees to enforce compliance
by its members with the provisions of the plan.\259\
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\258\ See proposed Rule 613(g)(2).
\259\ See proposed Rule 613(g)(3).
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Finally, the proposed Rule would require the NMS plan to include a
mechanism to ensure compliance with the requirements of the plan by the
members of a national securities exchange or national securities
association that is a sponsor of the NMS plan submitted pursuant to
this Rule and approved by the Commission.\260\ The purpose of this
provision is to require the SROs to implement a method to help ensure
compliance with the NMS plan and the corresponding SRO rules by their
members. Although the Commission is not proposing to mandate the format
of the mechanism, the Commission preliminarily believes that it could
include the imposition of fines on a member by an SRO of which it is a
member in the event the member failed to comply with any provision of
the NMS plan or the SRO's rules implementing the NMS plan. Any action
taken against the member, including the imposition of the fine by the
SRO, would be subject to the requirements of the SRO's other
rules.\261\
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\260\ See proposed Rule 613(g)(4).
\261\ See Sections 6(b)(6), 6(b)(7), and 6(d)(1) of the Exchange
Act, 15 U.S.C. 78f(b)(6), 78f(b)(7), and 78f(d)(1). See also, e.g.
FINRA Rule 9217, CHX Article 12, Nasdaq OMX BX Rule 9216 and IM-9216
and NYSE Rule 476A.
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The Commission requests comment on these provisions regarding
members' compliance with the proposed Rule and the NMS plan. Do
commenters believe that these provisions would encourage members'
compliance with the proposed Rule and the NMS Plan? If so, why? If not,
what other provisions would be necessary or appropriate to promote
compliance? What mechanisms should be part of a plan to promote
compliance by members? Would it be appropriate to include violations of
the proposed Rule, the NMS plan, or the SRO's rules implementing the
NMS plan within existing SRO rules that impose minimum fines for
violations of certain SRO rules? \262\ Would the exchanges or
associations have to amend their rules to implement such a requirement?
If so, how would they have to amend their rules? Are there other
alternatives that would more effectively help ensure the accuracy and
reliability of the information reported to the central repository by
members? Would requiring the SROs to file their proposed rule changes
to implement the requirements of the NMS plan with respect to the
members within 120 days after approval of the proposed Rule provide
sufficient time for SROs to draft the proposed rule changes? If not,
why not?
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\262\ See, e.g., FINRA Rule 9217 (providing for the imposition
of fines in lieu of commencing a formal disciplinary proceeding for
violations of certain rules, including the recording and reporting
requirements of the OATS rules) and NYSE Rule 476A (providing for
the imposition of fines in lieu of commencing a formal disciplinary
proceeding for violations of certain rules, including the OTS
rules).
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I. Operation and Administration of the NMS Plan
The proposed Rule would require that the NMS plan include a
governance structure to ensure fair representation of the plan
sponsors.\263\ The rule as proposed gives flexibility to the SROs to
devise a governance structure as they see fit. The proposed rule would
require the NMS plan to include a provision addressing the percentage
of votes required by the plan sponsors to effectuate amendments to the
plan.\264\ For example, the plan sponsors could determine to provide
each plan sponsor one vote on matters subject to a vote.\265\ Or, if
there was a concern that this method would result in ``blocs'' of plan
sponsors under common control exerting control in a one-sponsor, one-
vote system, the SROs could choose another alternative to ensure fair
representation.
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\263\ See proposed Rule 613(b)(1).
\264\ See proposed Rule 613(b)(3).
\265\ For example, Section 4.3 of the OPRA Plan provides that,
except as otherwise provided, each of the members of the Management
Committee shall be authorized to cast one vote for each Member that
he or she represents on all matters voted upon by the Management
Committee, and action of the Management Committee shall be
authorized by the affirmative vote of a majority of the total number
of votes the members of the Management Committee are authorized to
cast, subject to the approval of the Commission whenever such
approval is required under applicable provisions of the Exchange
Act, and the rules of the Commission adopted thereunder. Action of
the Management Committee authorized in accordance with the OPRA Plan
shall be without prejudice to the rights of any Member to present
contrary views to any regulatory body or in any other appropriate
forum.
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Further, most existing NMS plans require unanimous consent from the
plan sponsors to effect an amendment.\266\ The Commission recognizes
the unanimous consent requirement could be desirable because it helps
to ensure that no plan sponsor is forced to comply with requirements
with which it is unable to comply, or forced by the other sponsors to
pay fees. However, a unanimous consent requirement also could allow one
plan sponsor to effectively ``veto'' a provision desired by all other
plan sponsors for competitive reasons, or permit one sponsor to lag
behind in making updates to its systems or rules that would benefit the
industry as a whole. The Commission proposes to allow the plan sponsors
to determine whether to include in the NMS plan to be filed with the
Commission a unanimity requirement for effectuating amendments to the
plan, or some other convention.
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\266\ See, e.g., Securities Exchange Act Release Nos. 60405
(July 30, 2009), 74 FR 39362 (August 6, 2009) (order approving the
Options Order Protection and Locked/Crossed Market Plan) and 17638
(March 18, 1981), 22 S.E.C. Docket 484 (March 31, 1981) (order
approving the OPRA Plan).
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The Commission also recognizes that the scope or purpose of the
proposed NMS plan may differ from existing plans. The Commission
requests comment on whether there are lessons from previous experience
that suggest that the governance structure of the NMS plan to be filed
with the Commission should differ from existing plans. The Commission
requests comment on these provisions relating to the governance
structure of the plan. Should the Commission require certain governance
standards to ensure efficient
[[Page 32585]]
cooperation, or should the exchanges and association be allowed to
create a governance structure of their own choosing? What are the
relative merits of unanimity or super majority requirements? What are
the relative merits of alternative voting mechanisms and other
governance structures available to the plan sponsors? Should the voting
mechanism vary by the type of decision or should different decision
making bodies have authority over different types of decisions to avoid
situations where no decision is made because the sponsors cannot agree?
How should the governance and voting mechanisms be set up to avoid
inefficient operations or paralysis? Should there be limits on the time
frames given to make decisions? Should there be mechanisms to resolve
impasses once a decision has taken a certain amount of time? The
Commission also requests comment on whether the scope of the plan,
including the requirements on broker-dealers members, and the
expectation of improved surveillances for investor protection dictate
that the governance structure should differ from existing plans. In
particular, should the SRO sponsors be required to include in the
governance structure and decision-making authority representatives of
members to address member interests and independent representatives
chosen specifically to address investor and other public interests?
The proposed Rule also would require that the NMS plan include
provisions to govern the administration of the central repository,
including the selection of a plan processor. A ``plan processor'' is
defined in Rule 600 of Regulation NMS to mean any SRO or securities
information processor acting as an exclusive processor in connection
with the development, implementation and/or operation of any facility
contemplated by an effective national market system plan.\267\ The
Commission expects that the plan sponsors would engage in a thorough
analysis and formal competitive bidding process to choose the plan
processor. As proposed, the plan sponsors would be required to select a
person to act as the plan processor for the central repository no later
than two months after the effectiveness of the national market system
plan.\268\ The Commission preliminarily believes that this time frame
would provide the plan sponsors with sufficient time to choose the plan
processor, while providing that such entity would be in place with
enough time to create and build the central repository to receive data
from the SROs within one year after effectiveness of the NMS plan and
from the members within two years after such effectiveness.
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\267\ See 17 CFR 242.600(55).
\268\ See proposed Rule 613(a)(3)(i).
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The Commission requests comment as to whether the proposed Rule
should include specific requirements detailing the process for
selection of a plan processor. Should the Commission require specific
minimum requirements or standards that a plan processor should meet? If
so, what requirement or standards would be necessary or appropriate?
Should the plan processor be a non-SRO? Would this promote impartiality
on the part of the plan processor? The Commission also requests comment
on the proposed time frame to choose the plan processor. Is it too
short? Too long? If so, why? Please be specific in your response.
The proposed Rule also would require that the NMS plan contain a
requirement that a Chief Compliance Officer (``CCO'') be appointed to
regularly review the operation of the central repository.\269\ The CCO
would be expected to establish reasonable procedures designed to make
sure the operations of the central repository keep pace with technical
developments. To the extent upgrades or other changes are necessary to
assure the central repository's effectiveness, the CCO would be
responsible for making recommendations for enhancements to the nature
of the information collected and the manner in which it is processed.
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\269\ See proposed Rule 613(b)(5).
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The Commission requests comment on the necessity for a CCO to
oversee the operation of the central repository. If commenters support
the proposal to require a CCO, should the proposed Rule include a
requirement that the CCO be independent from the plan sponsors and
their members? That is, should the CCO be required to not have any
actual or potential conflicts of interest with respect to the plan
sponsors and their members (e.g. such as prior or future employment
with a plan sponsor or member, or a material business relationship with
a plan sponsor or member)? What are the risks of allowing a CCO who is
affiliated or associated with a plan sponsor or its members? What types
of conflicts of interest should be avoided? Are there any specific
qualifications that a CCO should possess? Should there be a specific
process in place for appointing a CCO or for removing a CCO for failure
to perform his or her assigned duties? Should there be a limit to the
number of years a CCO may serve as such?
The plan sponsors also would be required to include in the NMS plan
a provision addressing the requirements for the admission of new
sponsors to the plan and the withdrawal of sponsors from the plan.\270\
Proposed Rule 613(b)(4) also would require that the sponsors develop a
process for allocating among the plan sponsors the costs associated
with implementing and operating the central repository, including a
provision addressing the manner in which such costs would be allocated
to sponsors who join the plan after it was approved. Various NMS plans
have developed different ways to ensure that a fair cost or ``new
participant fee'' is assessed upon new plan sponsors.\271\ For example,
when determining a new participation fee, the OPRA Plan requires that
the following factors be considered: (1) The portion of costs
previously paid by OPRA for the development, expansion and maintenance
of OPRA's facilities which, under generally accepted accounting
principles, would have been treated as capital expenditures and would
have been amortized over the five years preceding the admission of the
new member; (2) an assessment of costs incurred and to be incurred by
OPRA for modifying the OPRA System or any part thereof to accommodate
the new member, which are not otherwise required to be paid or
reimbursed by the new Member; and (3) previous fees paid by other new
members. The plan sponsors could choose to include in the NMS plan to
be filed a similar provision or develop a new method for determining
the cost to join the plan that would better suit the NMS plan proposed
to be required by this Rule.
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\270\ See proposed Rule 613(b)(2).
\271\ See e.g. Section 7.1 of OPRA Plan.
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The Commission requests comment on whether the rule or plan should
specify a method for allocating costs among the plan sponsors. The
Commission also requests comment as to what provisions the exchanges
and FINRA should include in the NMS plan relating to the admission of
new plan sponsors and the withdrawal of existing plan sponsors. Should
the Commission specify the process for the admission of new plan
sponsors? What are the concerns, if any, that should be taken into
account when providing for the admission of new plan sponsors? The
Commission requests comment on all aspects of the proposed Rule
relating to governance and administration of the NMS plan.
[[Page 32586]]
J. Proposed Implementation Schedule
While the Commission preliminarily believes a comprehensive
consolidated audit trail would be useful as soon as possible, the
Commission also believes that it would be prudent to implement the Rule
at a measured pace to ensure that all market participants are fully
able to meet the requirements of the proposed Rule. Therefore, the
proposed Rule would provide that the proposed data collection and
submission requirements would first apply to national securities
exchanges and national securities associations, but not to their
individual members. As part of operating their businesses, the national
securities exchanges and national securities associations are
accustomed to handling large volumes of data and many already have in
place electronic trading, routing and reporting systems.\272\ Further,
under the proposal the exchanges would not be responsible for providing
to the central repository, for each order, information relating to the
customer. The Commission therefore preliminarily believes these systems
could more readily and quickly be modified than the members' systems to
comply with the requirements of the proposed Rule.
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\272\ For example, as part of COATS compliance, the options
exchanges are required to have in place systems to electronically
capture all order, transaction, and quotation information on the
exchange.
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Specifically, proposed Rule 613(a)(3)(iii) would require the
exchanges and associations to provide to the central repository the
data to be required by the Rule within one year after effectiveness of
the NMS plan. Members of the exchanges and associations would be
required to begin providing to the central repository the data required
by the proposed Rule two years after effectiveness of the NMS plan,
which would be one year following the implementation deadline for the
national securities exchanges and national securities
associations.\273\ This phased approach is designed to allow members
additional time to implement systems changes necessary to begin
providing the information to the central repository and to develop
procedures designed to capture customer and order information that they
may not have previously been required to collect to comply with other
Commission and SRO rules.
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\273\ See proposed Rule 613(a)(3)(v).
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The Commission requests comment on the proposed implementation time
periods. Are these time periods practical or feasible? Should they be
shorter? Longer? Please provide detailed reasons in your response. As
proposed, the national securities exchanges and national securities
associations would be required to submit data to the central repository
for one year before their members are required to submit data. Is
requiring the exchanges and FINRA to provide data before requiring
their members to do so a feasible way to phase in compliance with the
proposed rule? How would this phased-in approach affect the quality of
the data and the number of available data items in the audit trail? Are
there alternative ways to phase in implementation that would be more
practical? For instance, should the Commission consider requiring all
exchanges and FINRA and their respective members to begin reporting a
subset of the data initially, and phase in the collection of addition
data over time? Should the Commission require all exchanges, FINRA, and
their members to implement the proposed requirements first for NMS
stocks, then for listed options? Or vice versa? How should the
Commission take into consideration any concern commenters might have
that market participants might shift manipulative or other illegal
trading activity to products or markets not covered by the proposed
Rule in its analysis of whether, or how, to phase in compliance with
the proposed Rule across products classes (meaning, NMS stock and
listed options)? If so, how?
Should ATSs,\274\ including so-called dark pools,\275\ be required
to implement the proposed requirements before broker-dealers that are
not registered as ATSs? Would ATSs be able to more quickly comply with
the proposed recording and reporting requirements, since they generally
are highly automated and their business may be more narrowly focused
than, for example, broker-dealers that engage in a customer,
proprietary, and/or market making business? Are there any cost savings
associated with a phased approach to implementation? Would additional
unnecessary costs be incurred by implementing the plan in a phased-in
approach? Please provide data to support your views.
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\274\ See supra note 181.
\275\ Dark pools are ATSs that do not provide their best-priced
orders for inclusion in the consolidated quotation data. In general,
dark pools offer trading services to institutional investors and
others that seek to execute large trading interest in a manner that
will minimize the movement of prices against the trading interest
and thereby reduce trading costs. Dark pools fall within the
statutory definition of an exchange, but are exempted if they comply
with Regulation ATS. See Concept Release on Equity Market Structure,
supra note 19, at 3599, and supra note 181.
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IV. Request for Comments
We request and encourage any interested person to comment generally
on the proposed Rule. In addition to the specific requests for comment
throughout the release, the Commission requests general comment on all
aspects of proposed Rule 613 of Regulation NMS. The Commission
encourages commenters to provide information regarding the advantages
and disadvantages of each aspect of the proposed Rule. The Commission
invites commenters to provide views and data as to the costs and
benefits associated with the proposed Rule. The Commission also seeks
comment regarding other matters that may have an effect on the proposed
Rule. We request comment from the point of view of national securities
exchanges, national securities associations, members, investors, and
other market participants. With regard to any comments, we note that
such comments are of great assistance to our rulemaking initiative if
accompanied by supporting data and analysis of the issues addressed in
those comments.
V. Paperwork Reduction Act
Certain provisions of the proposal contain ``collection of
information requirements'' within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'') \276\ and the Commission has submitted
them to the Office of Management and Budget (``OMB'') for review in
accordance with 44 U.S.C. 3507 and 5 CFR 1320.11. An agency may not
conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid OMB
control number. The title of the new collection of information is
``Creation of a Consolidated Audit Trail Pursuant to Section 11A of the
Securities Exchange Act of 1934 and Rules Thereunder.''
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\276\ 44 U.S.C. 3501 et. seq.
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A. Summary of Collection of Information Under Proposed Rule 613
1. Creation and Filing of an NMS Plan
As detailed above, the proposed Rule would require each national
securities exchange and national securities association to jointly file
with the Commission, on or before 90 days from approval of the proposed
Rule, an NMS plan to govern the creation, implementation, and
maintenance of a consolidated audit trail and central repository for
the collection of information for NMS securities.\277\ The
[[Page 32587]]
NMS plan would be required to require each exchange or association and
its respective members to provide certain data to the central
repository in compliance with proposed Rule 613.\278\ The NMS plan also
would need to include certain specified provisions related to
administration and operation of the plan,\279\ and the operation of the
central repository.\280\ Further, the NMS plan would be required to
include certain provisions related to compliance by the exchanges and
associations and their members with the requirement of the proposed
Rule and the NMS plan.\281\
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\277\ See proposed Rule 613(a)(1) and supra Section III.
\278\ See proposed Rule 613(c) and supra Section III.D.
\279\ For example, the NMS plan would be required to include
provisions: (1) To ensure fair representation of the plan sponsors;
(2) for administration of the central repository; (3) addressing the
requirements for admission of new plan sponsors and withdrawal of
existing plan sponsors; (4) addressing the percentage of votes
required by the plan sponsors to effectuate amendments to the plan;
(5) addressing the manner in which the costs of operating the
central repository would be allocated among the national securities
exchanges and national securities associations that are sponsors of
the plan, including a provision addressing the manner in which costs
would be allocated to new sponsors to the plan. See proposed Rule
613(b).
\280\ For example, the NMS plan would be required to include a
provision requiring the creation and maintenance by the central
repository of a method of access to the data, including search and
reporting functions. See proposed Rule 613(e)(3). Additionally, the
NMS plan would be required to include policies and procedures,
including standards, to be used by the plan processor to: (1) Ensure
the security and confidentiality of all information submitted to,
and maintained by, the central repository; (2) ensure the
timeliness, accuracy, and completeness of the data provided to the
central repository; (3) require the rejection of data that does not
meet validation parameters and the retransmission of corrected data;
and (4) ensure the accuracy of the consolidation by the plan
processor of the data provided to the central repository. See
proposed Rule 613(e)(4).
\281\ The NMS plan would be required to include: (1) A provision
that by subscribing to and submitting the plan to the Commission,
each national securities exchange and national securities
association that is a sponsor to the plan agrees to enforce
compliance by its members with the provisions of the plan; and (2) a
mechanism to ensure compliance by the sponsors of the plan with the
requirements of the plan. See proposed Rule 613(g)(3) and (h)(3).
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Each national securities exchange and national securities
association would be required to be a sponsor of the NMS plan.\282\ The
Commission preliminarily believes that requiring the proposed NMS plan
would impose a paperwork burden on national securities exchanges and
national securities associations associated with preparing and filing
the joint NMS plan.
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\282\ See proposed Rule 613(a)(5).
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2. Report
Rule 613(i) also would require the national securities exchanges
and national securities associations to jointly provide to the
Commission a document outlining how such national securities exchanges
and national securities associations would propose to incorporate into
the consolidated audit trail information for: (1) Equity securities
that are not NMS securities; (2) debt securities; and (3) primary
market transactions in NMS stocks, equity securities that are not NMS
securities and debt securities.\283\ This report would be required to
specify in detail the data that would be collected and reported by each
market participant, an implementation timeline, and a cost estimate.
The Commission preliminarily believes that requiring the proposed
report would impose a paperwork burden on national securities exchanges
and national securities associations associated with preparing and
submitting the report to the Commission.
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\283\ See proposed Rule 613(i).
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3. Rule Filings by National Securities Exchanges and National
Securities Associations
Each national securities exchange and national securities
association would be required to file with the Commission, pursuant to
Section 19(b)(2) of the Exchange Act and Rule 19b-4 thereunder,\284\ a
proposed rule change to require its members to comply with the
requirements of the proposed Rule and the NMS plan submitted pursuant
to the proposed Rule and approved by the Commission of which the
national securities exchange or national securities association is a
sponsor.\285\ The burden of filing such proposed rule change would
already be included under the collection of information requirements
contained in Rule 19b-4 under the Exchange Act.\286\
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\284\ 15 U.S.C. 78s(b)(2) and 17 CFR 240.19b-4.
\285\ See proposed Rule 613(g)(1).
\286\ See Securities Exchange Act Release No. 50486 (October 5,
2004), 69 FR 60287, 60293 (October 8, 2004) (File No. S7-18-04)
(describing the collection of information requirements contained in
Rule 19b-4 under the Exchange Act). The Commission has submitted
revisions to the current collection of information titled ``Rule
19b-4 Filings with Respect to Proposed Rule Changes by Self-
Regulatory Organizations'' (OMB Control No. 3235-0045). According to
the last submitted revision concluded as of August 5, 2008, the
current collection of information estimates 1,279 total annual Rule
19b-4 filings with respect to proposed rule changes by self-
regulatory organizations.
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4. Collection and Retention of NBBO and Last Sale Data
The central repository would be required to collect and retain on a
current and continuing basis the national best bid and national best
offer for each NMS security, transaction reports reported pursuant to a
transaction reporting plan filed with the Commission pursuant to, and
meeting the requirements of, Rule 601 of Regulation NMS, and last sale
reports reported pursuant to the OPRA Plan.\287\ The central repository
would be required to retain this information for a period of not less
than five years.\288\
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\287\ See proposed Rule 613(e)(5); 17 CFR 242.601.
\288\ See proposed Rule 613(e)(6).
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5. Data Collection and Reporting
The proposed Rule would require each national securities exchange,
national securities association, and any member of such national
securities exchange or national securities association to collect and
electronically provide to the central repository details for each order
and reportable event documenting the life of an order through the
process of routing, modification, cancellation, and execution (in whole
or in part).\289\ The proposed Rule would require the collection and
reporting to the central repository of some information that national
securities exchanges, national securities associations, and their
members already are required to collect, and under certain
circumstances, report to a third party, in compliance with existing
Commission \290\ and SRO requirements.\291\ The proposed Rule
[[Page 32588]]
would, however, require exchanges, associations, and their members to
report to the central repository information not required to be
currently collected and reported pursuant to existing SRO audit trail
rules.
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\289\ See proposed Rule 613(c)(1) and supra Section III.D.
\290\ For example, Rule 17a-3 requires broker-dealers to
maintain the following information that would be captured by the
proposed Rule: Customer name and address; time an order was
received; and price of execution. 17 CFR 240.17a-3. Also, Rule 17a-
25 requires brokers to maintain the following information with
respect to customer orders: Date on which the transaction was
executed; account number; identifying symbol assigned to the
security; transaction price; the number of shares or option
contracts traded and whether such transaction was a purchase, sale,
or short sale, and if an option transaction, whether such was a call
or put option; the clearing house number of such broker or dealer
and the clearing house numbers of the brokers or dealers on the
opposite side of the transaction; prime broker identifier; the
customer's name and address; the customer's tax identification
number; and other related account information. 17 CFR 240.17a-25.
This information would be captured by the proposed Rule. See also
Section 17(a) of the Exchange Act, 15 U.S.C. 78q(a), and Rules 17a-1
and 17a-4 under the Exchange Act, 17 CFR 240.17a-1 and 17 CFR
240.17a-4.
\291\ The audit trail rules of several of the national
securities exchanges and FINRA require the following information be
recorded: Date order was originated or received by a member,
security or option symbol, clearing member organization, order
identifier, market participant symbol, number of shares executed,
designation of order as short sale, limit order, market order, stop
order or stop limit order, account type or number, date and time of
execution, and execution price and size. See BOX Ch. V, Section 4;
BX Rule 6955; FINRA Rule 7440; Nasdaq Options Market Chapter IX,
Section 4; Nasdaq Rule 6955; NYSE Rule 132B; and NYSE Amex Equities
Rule 132B. This information would be captured pursuant to the
proposed Rule.
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For example, although members of national securities exchanges and
national securities associations already should know the identity of
their customers, and in some instances may be required to provide that
information to the Commission or SRO staff upon request,\292\ the
requirement to electronically capture and report detailed information
sufficient to identify the customer to the central repository, in real
time, would be new. Further, although some existing audit trail
requirements include a unique order identifier,\293\ the proposed
Rule's requirement that the unique order identifier remain with the
order throughout its entire life, across markets and market
participants, would go beyond the current requirements. In addition,
although such members currently have unique market participant
identifiers (``MPIDs''), such MPIDs may differ across markets, whereas
the proposed Rule would require that each member have a unique
identifier that is the same across all markets. The proposed
requirements to report whether an order opens or closes a position for
NMS stocks, and to report borrow information, also are not required to
be marked on orders by current SRO or Commission rules. Further, much
of the information that would be required for the first time to be
reported to the central repository would be reported in real time, as
the event is occurring.
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\292\ See supra Section I.A. (discussing Rule 17a-25 and the EBS
system).
\293\ See supra Section I.C. (discussing the requirements of
FINRA's OATS).
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6. Central Repository
The proposed Rule would require that the central repository be
responsible for the receipt, consolidation, and retention of all data
submitted to the central repository by the national securities
exchanges, national securities associations, and their members.\294\
The proposed Rule also would require that (1) the central repository
retain the information collected pursuant to subparagraph (c)(7) and
(e)(5) of the proposed Rule in a convenient and usable standard
electronic data format that is directly available and searchable
electronically without any manual intervention for a period of not less
than five years, and (2) the information be available immediately, or
if immediate availability cannot reasonably and practically be
achieved, that any search query begin operating on the data not later
than one hour after the search query is made.\295\ The Commission notes
that a plan processor would be responsible for operating the central
repository in compliance with the proposed Rule and the NMS plan.
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\294\ See proposed Rule 613(e)(1). The Commission notes that a
plan processor would be responsible for operating the central
repository in compliance with the proposed Rule and the NMS plan.
\295\ See proposed Rule 613(e)(6).
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B. Proposed Use of Information
1. Creation and Filing of NMS Plan
As discussed in detail above, the NMS plan would govern the
creation, implementation, and maintenance of a consolidated audit trail
for NMS securities, which would aid the Commission and national
securities exchanges and national securities associations in
effectively and efficiently carrying out their regulatory
responsibilities. The information that would be collected pursuant to
the NMS plan would allow the SROs to more efficiently monitor trading
activity in the securities markets, and would facilitate the Commission
and the national securities exchanges and national securities
associations' trading reconstruction efforts as well as enhance their
monitoring, enforcement, and regulatory activities.
2. Report
As the Commission states above in Section III.A., it ultimately
intends for the proposed consolidated audit trail, if adopted, to be
expanded to cover other securities, including equity securities that
are not NMS securities, corporate bonds and other debt instruments;
credit default swaps and other security-based swaps; and any other
products that may come under the Commission's jurisdiction in the
future. Further, the Commission preliminarily believes that it would be
beneficial to expand the consolidated audit trail to include
information on primary market transactions in NMS stocks and other
equity securities that are not NMS stocks, as well as primary market
transactions in debt securities. The Commission preliminarily believes
that a timely expansion of the scope of the consolidated audit trail
beyond NMS securities would be beneficial as illegal trading strategies
that the consolidated audit trail would be designed to help detect and
deter, such as insider trading, may involve trading in multiple related
products other than NMS securities across multiple markets.
To help ensure that such an expansion would occur in a reasonable
time and that the systems and technology that would be used to
implement the Rule as proposed are designed to be easily scalable,
proposed Rule 613(i) would require that the NMS plan contain a
provision requiring each national securities exchange and national
securities association that is a sponsor of the plan to jointly provide
to the Commission within two months after effectiveness of the NMS plan
a document outlining how the sponsors would incorporate into the
consolidated audit trail information with respect to: (1) Equity
securities that are not NMS securities; (2) debt securities; and (3)
primary market transactions in NMS stocks, equity securities that are
not NMS securities, and debt securities. The sponsors specifically
would be required to address, among other things, details for each
order and reportable event that they would recommend requiring to be
provided; which market participants would be required to provide the
data; an implementation timeline; and a cost estimate. The Commission
would be able to use the information contained in the report in its
consideration and analysis of whether to expand the consolidated audit
trail.
3. Collection and Retention of NBBO and Last Sale Data
As discussed above, the requirement that the central repository
collect and retain the NBBO and transaction data in an electronic
format compatible with the order and event information collected
pursuant to the proposed Rule is intended to allow SRO and Commission
staff to easily search across order, NBBO, and transaction data bases.
The Commission preliminarily believes that having the NBBO information
in an electronic format compatible with the order audit trail
information would be useful for SROs to enforce compliance with federal
securities laws, rules and regulations.\296\ The Commission also
preliminarily believes that requiring the central repository to collect
and retain in its
[[Page 32589]]
database the transaction information in a format compatible with the
order execution information would aid the SROs in being able to monitor
for certain market manipulations.\297\
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\296\ The NBBO is used by SROs and the Commission to evaluate
members for compliance with numerous regulatory requirements, such
as the duty of best execution or Rule 611 of Regulation NMS. See
Rule 611 of Regulation NMS, 17 CFR 242.611. See also ISE Rule 1901,
NYSE Arca 6.94, and Phlx Rule 1084. An SRO would be able to compare
order execution information to the NBBO information on a more timely
basis because the order and execution information would be available
on a real time basis and all of the information would be available
in a compatible format in the same database. The SROs also may enjoy
economies of scale by adopting standard cross-market surveillance
parameters for certain types of violations.
\297\ See supra Section III.D.1.v. As discussed above, the
proposed Rule would require that each report of the execution (in
whole or in part) of an order sent to the central repository include
a notation as to whether the execution was reported to the
consolidated tape pursuant to an effective transaction reporting
plan or the OPRA Plan. This requirement should allow regulators to
more efficiently evaluate certain trading activity. For example,
trading patterns of reported and unreported trades may cause the
staff of an SRO or the Commission to make further inquiry into the
nature of the trading to ensure that the public was receiving
accurate and timely information regarding executions and that market
participants were continuing to comply with the trade reporting
obligations under SRO rules. Similarly, patterns in the reported and
unreported transactions could be indicia of market abuse, including
failure to obtain best execution for customer orders or possible
market manipulation. Being able to more efficiently compare the
consolidated order execution data with the trades reported to the
consolidated tape could thus be an important component of overall
surveillance activity.
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4. Data Collection and Reporting
As discussed above, the Commission preliminarily believes that the
data collection and reporting requirements of the proposed Rule would
enhance the ability of SRO staff to effectively monitor and surveil the
securities markets and thus detect and investigate potentially illegal
activity in a more timely fashion, whether on one market or across
markets. Further, the Commission preliminarily believes that the
ability to access such data would improve the ability of SRO staff to
conduct timely and accurate trading analysis for market reconstructions
and complex enforcement inquiries or investigations, as well as
inspections and examinations. Further, the Commission preliminarily
believes that the ability to access such data would aid the Commission
staff in its regulatory and market analysis efforts.
5. Central Repository
The central repository would be required to receive and retain the
data required to be submitted by the national securities exchanges,
national securities associations, and their members pursuant to the
proposed Rule. SROs and Commission staff would then have access to the
data for regulatory purposes, as discussed above.
C. Respondents
1. National Securities Exchanges and National Securities Associations
Proposed Rule 613 would apply to all of the fourteen national
securities exchanges and to one national securities association (FINRA)
currently registered with the Commission.
2. Members of National Securities Exchanges and National Securities
Associations
Proposed Rule 613 would apply to the approximately 5,178 broker-
dealers that are currently registered with the Commission and are
members of the national securities exchanges or FINRA.\298\
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\298\ This is the number of broker-dealers filing FOCUS Reports
at year-end 2008. FOCUS Reports are required to be filed by all
registered broker-dealers, with a few exceptions. Excluded from this
number were recently established broker-dealers that had yet to
become active, or broker-dealers no longer doing business that had
yet to deregister.
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D. Total Annual Reporting and Recordkeeping Burden
1. Burden on National Securities Exchanges and National Securities
Associations
a. Creation and Filing of NMS Plan
Proposed Rule 613 would require the national securities exchanges
and FINRA to jointly file with the Commission a joint NMS plan to
govern the creation, implementation, and maintenance of a consolidated
audit trail and a central repository. The Commission estimates that it
would take each national securities exchange and national securities
association approximately 840 burden hours of internal legal,
compliance, information technology, and business operations time to
develop and file the NMS plan, including the required provisions
regarding governance, administration, and operation of the plan.\299\
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\299\ The Commission derived the total estimated burdens from
the following estimates, which are based on the Commission's
understanding of, and burden estimates for, existing NMS plans:
(Attorney at 400 hours) + (Compliance Manager at 100 hours) +
(Programmer Analyst at 220 hours) + (Business Analyst at 120 hours).
The Commission preliminarily believes that the cost of developing
and filing the NMS plan pursuant to the proposed Rule would be
comparable to the cost to create other existing NMS plans,
recognizing that the proposed Rule may include more detail as to
what must be incorporated and addressed in the NMS plan implementing
the proposed Rule.
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The Commission preliminarily expects that national securities
exchange and national securities association respondents may incur one-
time external costs for outsourced legal services to develop and draft
the NMS plan. While the Commission recognizes that the amount of legal
outsourcing used may vary from SRO to SRO, the staff estimates that on
average, each national securities exchange and national securities
association would outsource 50 hours of legal time to develop and draft
the NMS plan, for a capital cost of approximately $20,000 for each
national securities exchange and national securities association
resulting from outsourced legal work.\300\ Therefore, the Commission
preliminarily estimates that the average one-time initial burden of
developing and filing the NMS plan would be 840 burden hours plus
$20,000 external costs for outsourced legal counsel per SRO, for an
aggregate estimated burden of 12,600 hours plus $300,000 external
costs.
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\300\ Based on industry sources, the Commission estimates that
the hourly rate for outsourced legal services in the securities
industry is $400 per hour.
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Once the national securities exchanges and national securities
associations have established the NMS plan, the Commission estimates
that, on average, each national securities exchange and national
securities association would incur 192 burden hours annually to ensure
that the NMS plan is up to date and remains in compliance with the
proposed Rule,\301\ for an aggregate estimated burden of 2,880 hours.
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\301\ The Commission derived the total estimated burdens from
the following estimates, which are based on prior Commission
experience with burden estimates: (Attorney at 64 hours) +
(Compliance Manager at 64 hours) + (Programmer Analyst at 64 hours)
= 192 burden hours.
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b. Report
The Commission estimates that it would take each national
securities exchange or national securities association approximately
420 burden hours of internal legal, compliance, business operations and
information technology staff time to create the report required by the
proposed Rule.\302\ The Commission also expects that each national
securities exchange and national securities association respondent may
incur one-time external costs for outsourced legal services helping to
prepare the report. Commission estimates that on average, each national
securities exchange and national securities association would outsource
25 hours of legal time to create the report, for an aggregate one-time
capital cost of approximately $10,000.\303\ Therefore, the Commission
[[Page 32590]]
preliminarily estimates that the one-time initial burden of drafting
the report required by the proposed Rule would be 420 burden hours plus
$10,000 external costs for outsourced legal counsel per SRO, for an
aggregate estimated burden of 6,300 hours and $150,000 external costs.
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\302\ The Commission derived the total estimated burden from the
following estimates, which assumes preparation of the report would
impose approximately half of the approximate burden of preparing the
plan, reflects half of the approximate burden of drafting and filing
the NMS plan, and the Commission's preliminary view that the cost of
preparing the report would not be as extensive as the drafting and
filing of the NMS plan: (Attorney at 200 hours) + (Compliance
Manager at 50 hours) + (Programmer Analyst at 110 hours) + (Business
Analyst at 60 hours) = 420 burden hours per SRO.
\303\ The Commission derived the total estimated burden for
outsourced legal counsel based on the assumption that the report
required by the proposed Rule would require approximately half the
effort of drafting and filing the proposed NMS plan.
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c. Data Collection and Reporting
The proposed Rule would require the collection and reporting on a
real time basis of some information that national securities exchanges
and national securities associations already collect to operate their
business, and are required to maintain in compliance with Section 17(a)
of the Exchange Act and Rule 17a-1 thereunder.\304\ For instance, the
Commission believes that exchanges keep records pursuant to Section
17(a) of the Exchange Act and Rule 17a-1 thereunder in electronic form,
of the receipt of all orders entered into their systems, as well as
records of the routing, modification, cancellation, and execution of
those orders. However, the proposed Rule would require each SRO to
collect and report additional and more detailed information, and to
report the information to the central repository in real time in a
specified uniform format. The Commission anticipates that exchanges may
need to enhance or replace their current systems to be able to comply
with the proposed information collection and reporting requirements of
the proposed Rule.
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\304\ 15 U.S.C. 78q(a); 17 CFR 240.17a-1.
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The Commission recognizes that the extent to which a particular SRO
would need to make systems changes would differ depending upon the
SRO's current market structure and existing systems. However, the
Commission preliminarily estimates that, on average, the initial one-
time burden per national securities exchange and national securities
association for development and implementation of the systems needed to
capture the required information and transmit it to the central
repository in a specified format in compliance with the proposed Rule
to be 2,200 hours.\305\ Further, the Commission estimates that, on
average, each exchange and association would incur approximately 40
hours of outsourced legal counsel legal time for the development and
implementation of systems needed to capture the required information
and transmit it to the central repository, and a one-time software and
hardware cost of $4,542,940 per SRO to develop and implement the
necessary systems. Therefore, the Commission preliminarily estimates
that the average one-time initial burden per national securities
exchange and national securities association for development and
implementation of the systems needed to capture the required
information and transmit it to the central repository in a specified
format in compliance with the proposed Rule would be 2,200 burden hours
plus $16,000 costs for outsourced legal counsel and $4,542,940 for
hardware and software costs,\306\ for an aggregate estimated burden of
33,000 hours and $68,384,100 external and systems costs.
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\305\ The Commission derived the total estimated burdens from
the following estimates, which reflect the Commission's experience
with, and burden estimates for, SRO systems changes, and discussions
with market participants: (Attorney at 100 hours) + (Compliance
Manager at 80 hours) + (Programmer Analyst at 1,960 hours) +
(Business Analyst at 60 hours) = 2,200 burden hours per SRO.
\306\ These estimates are based on the Commission's previous
experience with, and cost estimates for, SRO systems changes, and
discussions with market participants. See Securities Exchange Act
Release No. 50870 (December 16, 2004), 69 FR 77424 (December 27,
2004) (``Regulation NMS Reproposing Release'') at 77480 (discussing
costs to implement Rule 611 of Regulation NMS). Although the
Commission recognizes that the substance of Rule 611 of Regulation
NMS is not the same as the proposed Rule, the Commission
preliminarily believes that the scope of the systems changes would
be comparable.
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Once a national securities exchange or national securities
association has established the appropriate systems required for
collection and transmission of the required information to the central
repository in a specified format, the Commission preliminarily believes
that it would be necessary for each national securities exchange or
national securities association to undertake efforts to ensure that
their system technology is up to date and remains in compliance with
the proposed Rule, which could include personnel time to monitor each
SRO's reporting of the required data and the maintenance of the systems
to report the required data; activity related to adding extra systems
capacity to accommodate new order types that would need to be reported
to the central repository; or implementing changes to trading systems
which might result in additional reports to the central repository. The
Commission preliminarily estimates that, on average, it would take a
national securities exchange or national securities association
approximately 4,975 hours per year to ensure that the system technology
is up to date and remains in compliance with the proposed Rule.\307\
The Commission also estimates that it would cost, on average,
approximately $1.25 million per year per SRO to continue to comply with
the proposed requirements to provide information to the central
repository, including costs to maintain the systems connectivity to the
central repository and purchase any necessary hardware, software, and
other materials.\308\ Therefore, the Commission preliminarily estimates
that the average ongoing annual burden per SRO would be approximately
4,975 hours plus $1.25 million external costs to maintain the systems
necessary to collect and transmit information to the central
repository, for an aggregate estimated annual burden of 74,625 hours
and $18,750,000 external systems costs.
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\307\ The Commission derived the total estimated burdens from
the following estimates, which reflect the Commission's preliminary
view that annual ongoing costs would be approximately half the costs
of developing and implementing the systems to capture the required
information and transmit it to the central repository, and
discussions with market participants: (Attorney at 1,500 hours) +
(Compliance Analyst at 1,600 hours) + (Programmer Analyst at 1,375
hours) + (Business Analyst at 500 hours) = 4,975 burden hours per
SRO.
\308\ This estimate includes an estimated cost of approximately
$10,000 per month to maintain systems connectivity to the central
repository, including back-up connectivity. This estimate is based
on discussions with a market participant.
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d. Central Repository
The proposed Rule would require national securities exchanges and
national securities associations to jointly establish a central
repository tasked with the receipt, consolidation, and retention of the
reported order and execution information. The central repository thus
would need its own system(s) to receive, consolidate, and retain the
electronic data received from the SROs and their members. The system
would be required to be accessible by the sponsors and the Commission
for regulatory purposes, with validation parameters allowing the
central repository to automatically check the accuracy and completeness
of the data submitted, and reject data not conforming to these
parameters. It is anticipated that the burdens of development and
operation of the central repository would be shared among the plan
sponsors.
The Commission staff preliminarily estimates that there would be an
average initial one-time burden of 17,500 hours per plan sponsor for
development and implementation of the systems needed to capture the
required information in compliance with the proposed Rule.\309\
[[Page 32591]]
Further, the Commission estimates that each exchange and association
would incur software and hardware costs of approximately $4 million per
plan sponsor related to systems development. Therefore, the Commission
preliminarily estimates a one-time initial burden of 17,500 hours per
plan sponsor, plus software and hardware costs of approximately $4
million related to systems development,\310\ for an aggregate estimated
burden of 262,500 hours and $60 million in external systems costs.
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\309\ The Commission derived the total estimated burdens based
on the following estimates, which are based on information provided
to the Commission regarding the development of reporting systems for
the collection, consolidation, and dissemination of quotation and
last sale data and discussions with market participants: (Attorney
at 3,000 hours) + (Compliance Manager at 4,000 hours) + (Programmer
Analyst at 7,500 hours) + (Business Analyst at 3,000 hours) = 17,500
per SRO. This figure excludes the number of burden hours required to
create and file the NMS plan.
\310\ This cost estimate includes the estimated costs that each
exchange and association would incur for software and hardware costs
related to systems development. This cost estimate also would
encompass (1) costs related to engaging in an analysis and formal
bidding process to choose the plan processor, and (2) any search
undertaken to hire a CCO. See proposed Rule 613(a)(3)(i) (the plan
sponsors would be required to select a person to act as a plan
processor for the central repository no later than two months after
the effectiveness of the NMS plan) and 613(b)(5) (the plan sponsors
would be required to appoint a CCO to regularly review the operation
of the central repository to assure its continued effectiveness in
light of market and technological developments, and make any
appropriate recommendations for enhancements to the nature of the
information collected and the manner in which the information is
processed).
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Once the plan sponsors have established the systems necessary for
the central repository to receive, consolidate, and retain the required
information, the Commission estimates that the burden per plan sponsor
to ensure that the system technology and functionality is up to date
and remains in compliance with the proposed Rule would be 192 hours per
year, for an estimated aggregate burden per year of 2,880 hours.\311\
The estimated burden would include actions taken to regularly review
the operation of the central repository to assure its continued
effectiveness and to determine the need for enhancements to accommodate
the information required to be collected, or new information collected,
and the manner in which the data is processed, as well as periodic
assessments of the adequacy of the system technology and functionality
of the central repository.
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\311\ The Commission derived the total estimated burdens from
the following estimates, which are based on prior Commission
experience with burden estimates: (Attorney at 16 hours) +
(Compliance Manager at 16 hours) + (Programmer Analyst at 16 hours)
= 48 burden hours per quarter, or 192 burden hours per year.
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After the central repository systems have been developed and
implemented, there would be ongoing costs for operating the central
repository, including the cost of paying the CCO; the cost of systems
and connectivity upgrades or changes necessary to receive, consolidate,
and store the reported order and execution information from SROs and
their members; the cost, including storage costs, of collecting and
maintaining the NBBO and transaction data in a format compatible with
the order and event information collected pursuant to the proposed
Rule; the cost of monitoring the required validation parameters, which
would allow the central repository to automatically check the accuracy
and completeness of the data submitted and reject data not conforming
to these parameters consistent with the requirements of the proposed
Rule; and the cost of compensating the plan processor. The Commission
preliminarily assumes that the plan processor would be responsible for
the ongoing operations of the central repository. The Commission
estimates that these costs would be approximately $100 million in
external costs to the plan processor for operation of the central
repository per year, or approximately $6,666,666 per plan sponsor per
year.\312\
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\312\ The Commission derived the total estimated burdens based
on discussions with market participants. The estimated annual cost
includes an annual salary for a CCO of $703,800. This figure is
based on a $391 per-hour figure for a Chief Compliance Officer from
SIFMA's Management & Professional Earnings in the Securities
Industry 2008, modified by Commission staff to account for an 1,800-
hour work-year and multiplied by 5.35 to account for bonuses, firm
size, employee benefits, and overhead.
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e. Collection and Retention of the NBBO and Transaction Reports
The proposed Rule would require that the central repository collect
and retain on a current and continuous basis the NBBO for each NMS
security, transaction reports reported pursuant to an effective
transaction reporting plan, and last sale reports reported pursuant to
the OPRA Plan. The central repository would be required to maintain
this NBBO and transaction data in a format compatible with the order
and event information collected pursuant to the proposed Rule.\313\
Further, the central repository would be required to retain the
information collected pursuant to paragraphs (c)(7) and (e)(5) of the
proposed Rule in a convenient and usable standard electronic data
format that is directly available and searchable electronically without
any manual intervention for a period of not less than five years. The
information would be required to be available immediately, or if
immediate availability could not reasonably and practically be
achieved, any search query would be required to begin operating on the
data not later than one hour after the search query is made.\314\
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\313\ See proposed Rule 613(e)(5).
\314\ See proposed Rule 613(e)(6).
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The Commission preliminarily has included in the burden estimates
to the plan sponsors of developing and implementing the systems
necessary to capture the order audit trail information (see supra
Section V.D.1.d) the: (1) Initial one-time hour burden per plan sponsor
for development and implementation of the systems at the central
repository necessary to receive and retain this NBBO and last sale
information; (2) associated software and hardware costs; and (3)
ongoing costs of receiving and retaining the NBBO and last sale
information.\315\
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\315\ See supra Section V.D.1.d.
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The Commission estimates that the ongoing external costs to receive
the NBBO and last sale data from the SIPs would be approximately $1,370
per year.\316\
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\316\ The Commission derived this estimate based on the average
current cost of obtaining consolidated quotation and transaction
information from existing quotation and transaction reporting plans.
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2. Members
The Commission preliminarily believes that the proposed Rule would
require the collection and reporting in real time of much of the
information that registered broker-dealers already maintain in
compliance with existing regulations.\317\ For example, Section 17 of
the Exchange Act and Rule 17a-3 thereunder mandate that broker-dealers
keep certain records of orders handled during the course of
business.\318\ Certain information also is required to be collected and
reported by broker-dealers in compliance with a Commission request
pursuant to Rule 17a-25 under
[[Page 32592]]
the Exchange Act.\319\ The proposed Rule would, however, require SRO
members to collect and report additional information for each order in
a specified uniform format. In addition to the new information, the
members also would be required to report most of the information on a
real time basis to the central repository, which is not currently
required. The Commission anticipates that SRO members would need to
either enhance or replace their current order handling, trading, and
other systems to be able to collect and report the required order and
reportable event information to the central repository as required by
the proposed Rule.
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\317\ See Section 17(a) of the Exchange Act, 14 U.S.C. 78q(a),
and Rules 17a-3, 17a-4, and 17a-25 under the Exchange Act, 17 CFR
240.17a-3, 17 CFR 240.17a-4, and 17 CFR 240.17a-25; see also, e.g.,
BATS Rule 20.7; BOX Chapter V, Section 4; CBOE Chapter VI, Rule
6.24; CHX Article 11, Rule 3; FINRA Rule 7440; Nasdaq Options Market
Chapter IX, Section 4; NYSE Rule 132B; and NYSE Amex Equities Rule
132B.
\318\ 15 U.S.C. 78q et seq.; 17 CFR 240.17a-3. Generally,
broker-dealers must keep a memorandum of each brokerage order,
including the following information: The terms and conditions of an
order or instructions; the account for which an order was entered;
time of order entry and receipt and, to the extent feasible, time of
execution; any modifications or cancellations (and, to the extent
feasible, time of cancellation); execution price; and the identity
of each associated person, if any, responsible for the account. See
Rule 17a-3(a)(6)(i) under the Exchange Act, 17 CFR 240.17a-
3(a)(6)(i). Broker-dealers also are required to keep a record for
each cash and margin account they hold, and the name and address of
the beneficial owner of each such account. See Rule 17a-3(a)(9)
under the Exchange Act, 17 CFR 240.17a-3(a)(9).
\319\ See supra Section I.A for a detailed discussion of what
information is required to be submitted upon request to the
Commission pursuant to Rule 17a-25 under the Exchange Act, 17 CFR
240.17a-25.
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The Commission recognizes that the extent to which a particular
member would need to make systems changes or replace existing systems
would differ depending upon the member's current business operations
and systems. The Commission preliminarily believes that members that
rely mostly on their own internal order routing and execution
management systems would need to make changes to or replace such
systems to collect and report the required order and reportable event
information to the central repository as required by the proposed Rule.
The Commission estimates that there are approximately 1,114 of these
types of members.\320\ The Commission preliminarily estimates the
average initial one-time burden to develop and implement the needed
systems changes to capture the required information and transmit it to
the central repository in compliance with the proposed Rule for these
members would be approximately 6,530 burden hours.\321\ The Commission
also preliminarily estimates that these members would, on average,
incur approximately $1.5 million in one-time external costs for
hardware and software to implement the systems changes needed to
capture the required information and transmit it to the central
repository.\322\ Therefore, the Commission preliminarily estimates that
the average one-time initial burden per member would be 6,530 hours and
$1.5 million, for an estimated aggregate burden of 7,274,420 hours and
$1,671,000,000.
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\320\ This number includes members that are clearing broker-
dealers that carry customer accounts; broker-dealers that accept
customer monies but do no margin business; introducing brokers that
clear proprietary securities transactions; ATSs registered with the
Commission; other clearing firms; and registered market makers. This
number was derived from annual FOCUS reports filed with the
Commission for the year ending in 2008.
\321\ The Commission derived the total estimated burdens on the
following estimates, which reflect the Commission's previous
experience with, and burden estimates for, broker-dealer systems
changes, and discussions with market participants: (Attorney at
1,240 hours) + (Compliance Manager at 1,540 hours) + (Programmer
Analyst at 2,750 hours) + (Business Analyst at 1,000 hours) = 6,530
hours.
\322\ These estimates are based on the Commission's previous
experience with, and cost estimates for, broker-dealer systems
changes, and discussions with market participants. See Regulation
NMS Reproposing Release, supra note 306, at 77480 (discussing costs
to implement Rule 611 of Regulation NMS). Although the Commission
recognizes that the substance of Rule 611 of Regulation NMS is not
the same as the proposed Rule, the Commission preliminarily believes
that the scope of the systems changes would be comparable.
These estimated hour burdens and systems costs would include the
burden and costs, if any, that would be incurred by members to
obtain the required customer information, including beneficial
ownership, store it electronically, and transmit it to the central
repository.
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This number would likely overestimate the costs for some of these
members and underestimate it for others. For example, it may
overestimate the cost for ATSs as opposed to members that engage in a
customer and proprietary (or market marking) business, in part because
of the narrower business focus of some ATSs.\323\ The Commission also
recognizes that some or all of these members may contract with one or
more outside vendors to provide certain front-end order management
systems. The third-party vendor may make changes to its systems to
permit the members that use the system to capture and provide the
required information to the central repository. Likewise, some or all
of these members may contract with outside vendors to provide back-
office functionality. These third-party vendors may make changes to
their systems to permit the members that use the systems to capture and
provide the required information to the central repository. The cost of
these changes may be shared by the various members that use the
systems, and thus may result in a reduced cost to an individual member
to implement changes to its own systems to comply with the requirements
of the proposed Rule.
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\323\ See Regulation NMS Reproposing Release, supra note 306, at
77480.
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Once such a member has established the appropriate systems and
processes required for collection and transmission of the required
information to the central repository, the Commission estimates that
the proposal would impose on each member ongoing annual burdens
associated with, among other things, personnel time to monitor each
member's reporting of the required data and the maintenance of the
systems to report the required data; activity related to adding extra
systems capacity to accommodate new order types that would need to be
reported to the central repository; or implementing changes to trading
systems which might result in additional reports to the central
repository. The Commission preliminarily estimates that, on average, it
would take a member of a national securities exchange or national
securities association approximately 3,050 burden hours per year
continued compliance with the proposed Rule.\324\ The Commission also
estimates that it would cost, on average, approximately $756,000 per
year per member to maintain the systems connectivity to the central
repository and purchase any necessary hardware, software, and other
materials.\325\ Therefore, the Commission preliminarily estimates that
the average ongoing annual burden per member would be approximately
3,050 hours, plus $756,000 external costs to maintain the systems
necessary to collect and transmit information to the central
repository, for an estimated aggregate annual burden of 3,397,700 hours
and $842,184,000.
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\324\ The Commission derived the total estimated burdens on the
following estimates, which reflect the Commission's preliminary view
that ongoing costs would be approximately half of the costs of
developing and implementing the systems to comply with the proposed
Rule: (Attorney at 800 hours) + (Compliance Manager at 1,000 hours)
+ (Programmer Analyst at 500 hours) + (Business Analyst at 750
hours) = 3,050 burden hours.
\325\ This estimate includes an estimated cost of approximately
$10,000 per month to maintain systems connectivity to the central
repository, including back-up connectivity. This estimate is based
on discussions with a market participant.
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The Commission preliminarily believes that other members generally
would rely on functionality provided by third parties to electronically
capture the required information and transmit it to the central
repository in real time. For purposes of the proposed Rule, the
Commission assumes that these members, which could include broker-
dealers defined as ``small entities'' for purposes of the Regulatory
Flexibility Act,\326\ generally do not clear transactions and may not
possess their own internal order routing and execution management
systems, but instead rely on third-party providers for such
functionality. Further, the Commission assumes that many of these
members currently do not themselves report order or trade information
and instead rely on their clearing firms or other third parties to do
it for them.
[[Page 32593]]
These smaller members may look for ``turn key'' systems that could
provide the functionality required by the proposed Rule. As such, the
Commission preliminarily believes that these members would not
undertake a fundamental restructuring of their business to comply with
the proposed Rule. Instead, they might continue to rely on their
clearing broker-dealer, or they might purchase a standardized software
product provided by a third party that would provide the functionality
to electronically capture the required information and transmit it to
the central repository in real time. The Commission estimates that
there are approximately 3,006 of these types of members.\327\ For these
members, Commission staff preliminarily estimates the average external
cost to compensate a third party, whether the clearing broker-dealer or
other third party, for software that would provide the necessary
functionality to electronically capture the required information and
transmit it to the central repository, would be approximately $50,000
per member.\328\ In addition, the Commission preliminarily estimates
that each of these members, on average, would incur a one-time burden
of 140 hours to incorporate this functionality.\329\ Therefore, the
Commission preliminarily estimates an initial aggregate burden of
420,840 hours and $150,300,000.
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\326\ See infra Section IX.
\327\ This number includes introducing broker-dealers that do
not clear transactions. This number excludes non-clearing firms that
specialize in direct participation programs; non-clearing firms that
sell insurance products; and non-clearing firms that are
underwriters and retailers of mutual funds because these firms do
not deal in NMS securities. This number was derived from annual
FOCUS reports filed with the Commission for the year ending in 2008.
\328\ This estimate is based on the Commission's previous
experience with, and burden estimates for, broker-dealer systems
changes. See Regulation NMS Reproposing Release, supra note 306, at
77480 (discussing costs to implement Rule 611 of Regulation NMS).
Although the Commission recognizes that the substance of Rule 611 of
Regulation NMS is not the same as the proposed Rule, the Commission
preliminarily believes that the scope of the systems changes would
be comparable.
\329\ The Commission derived the estimated burdens from the
following estimates, which are based on prior Commission experience
with burden estimates: (Attorney at 50 hours) + (Compliance Manager
at 50 hours) + (Programmer Analyst at 40 hours) = 140 hours.
These estimated hour burdens and systems costs would include the
burden and costs, if any, that would be incurred by members to
obtain the required customer information, including beneficial
ownership, store it electronically, and transmit it to the central
repository.
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Once such a member has procured the appropriate third party
system(s) for collection and transmission of the required information
to the central repository, the Commission preliminarily estimates that
such a member would continue to incur, on average, an external cost of
$50,000 annually to compensate a third party, whether the clearing
broker-dealer or for software that would provide the necessary
functionality to capture the required information and transmit it to
the central repository. The Commission also preliminarily estimates
that each such member would incur a cost for compliance personnel
necessary to oversee continued compliance with the proposed Rule, which
would result in 64 burden hours annually for such member.\330\
Therefore, the Commission preliminarily estimates an aggregate ongoing
burden of 192,384 hours and $150,300,000 to ensure compliance with the
proposed Rule.
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\330\ The Commission bases this estimate one a full-time
Compliance Manager spending approximately 2 days per quarter of his
time on overseeing ongoing compliance with the proposed Rule.
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The Commission requests specific comments on each of its estimates
with respect to the estimated burden and costs on members to comply
with the proposed Rule. In particular, the Commission requests comment
on the specific types and amount of costs, as well as internal staff
burden, that would be incurred to modify members' order handling,
trading, and other systems to comply with the proposed Rule. The
Commission requests comment whether, and if so how, the estimated costs
would be impacted if the members did not have to provide the
information in proposed Rule 613(c)(7)(vi) and (vii) (the non-real time
information).\331\ For instance, would requiring the reporting to the
central repository of the account numbers for any subaccounts to which
an execution is allocated, and the amount of a commission, if any, paid
by the customer and the unique identifier of the broker-dealer(s) to
whom the commission is paid, require changes to systems other than
order handling and execution systems?
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\331\ Proposed Rule 613(c)(7)(vi) would require the reporting to
the central repository of the following information: (1) The account
number for any subaccounts to which the execution is allocated (in
whole or part); (2) the unique identifier of the clearing broker or
prime broker, if applicable; (3) the unique order identifier of any
contra-side order(s); (4) special settlement terms, if applicable;
(5) short sale borrow information and identifier; and (6) the amount
of a commission, if any, paid by the customer, and the unique
identifier of the broker-dealer(s) to whom the commission is paid.
Proposed Rule 613(c)(7)(vii) would require the reporting to the
central repository of a cancelled trade indicator, if the trade is
cancelled.
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E. Collection of Information Is Mandatory
Each collection of information discussed above would be a mandatory
collection of information.
F. Confidentiality
The proposed Rule would require that the information to be
collected and electronically provided to the central repository would
only be available to the national securities exchanges, national
securities association and the Commission for the purpose of performing
their respective regulatory and oversight responsibilities pursuant to
the federal securities laws, rules, and regulations.\332\ Further, the
national market system plan submitted pursuant to the proposed Rule
would be required to include policies and procedures to ensure the
security and confidentiality of all information submitted to the
central repository, and to ensure that all plan sponsors and their
employees, as well as all employees of the central repository, shall
use appropriate safeguards to ensure the confidentiality of such data
and shall agree not to use such data for any purpose other than
surveillance and regulatory purposes.\333\
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\332\ See proposed Rule 613(e)(2).
\333\ See proposed Rule 613(e)(4)(i).
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G. Retention Period of Recordkeeping Requirements
National securities exchanges and national securities associations
would be required to retain records and information pursuant to Rule
17a-1 under the Exchange Act.\334\ Members would be required to retain
records and information in accordance with Rule 17a-4 under the
Exchange Act.\335\
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\334\ 17 CFR 240.17a-1.
\335\ 17 CFR 240.17a-4.
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H. Request for Comments
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comment to: (1) Evaluate whether each proposed collection of
information is necessary for the performance of the functions of the
agency, including whether the information shall have practical utility;
(2) evaluate the accuracy of the agency's estimate of the burden of
each proposed collection of information; (3) enhance the quality,
utility, and clarity of the information to be collected; and (4)
minimize the burden of each collection of information on those who are
to respond, including through the use of automated collection
techniques or other forms of information technology.
[[Page 32594]]
VI. Consideration of Costs and Benefits
The Commission is sensitive to the anticipated costs and benefits
of the proposed Rule and requests comments on the costs and benefits of
the proposed Rule. The Commission encourages commenters to identify,
discuss, analyze, and supply relevant data regarding any such costs or
benefits.
A. Benefits
Proposed Rule 613 would require all national securities exchanges
and national securities associations to jointly submit to the
Commission an NMS plan to create, implement, and maintain a
consolidated audit trail. The proposed consolidated audit trail would
capture, in real time, certain information about each order (including
quotations) for an NMS security, including the identity of the customer
placing the order, and the details of routing, modification,
cancellation, and execution (in whole or in part). In effect, an
``electronic audit trail report'' would be created for every event in
the life of the order. The consolidated audit trail would be maintained
by a central repository, and all exchanges, FINRA and the Commission
would have access to the consolidated audit trail data for regulatory
purposes.
The Commission preliminarily believes that proposed Rule 613 would
significantly aid each of the exchanges and FINRA in carrying out its
respective statutory obligations to be organized and have the capacity
to comply, and enforce compliance by its members, with its rules, and
with the federal securities laws, rules, and regulations. Likewise, the
Commission believes that proposed Rule 613 would significantly aid the
Commission in its ability to oversee the exchanges and associations,
and to enforce compliance by the members of exchanges and associations
with the respective exchange's or association's rules, and the federal
securities laws and regulations. The proposed consolidated audit trail
also would aid the Commission in its efforts to limit the manipulation
of security prices, and to limit the use of manipulative or deceptive
devices in the purchase or sale of a security. Further, the proposal
would benefit exchanges, FINRA, and Commission staff by improving the
ability of exchanges, FINRA and Commission staff to conduct more timely
and accurate trading analysis for market reconstructions, complex
enforcement inquiries or investigations, as well as inspections and
examinations.
Specifically, the Commission preliminarily believes that, as
proposed, Rule 613 would enable exchanges and FINRA to more effectively
and efficiently detect, investigate, and deter illegal trading
activity, particularly cross-market illegal activity, in furtherance of
their statutory obligations. In addition, the Commission preliminarily
believes that proposed Rule 613 would enhance the ability of the
Commission staff in its regulatory and market analysis efforts. The
proposed rule would achieve these objectives in several ways. First,
proposed Rule 613 would require the central repository to collect the
same data on customer and order event information from each exchange,
FINRA, and all members of the exchanges and FINRA, in a uniform format.
Currently, the scope and format of audit trail information relating to
orders and executions differs, sometimes significantly, among exchanges
and FINRA. Thus, by requiring that all exchanges, FINRA and their
members submit uniform customer and order event data to the central
repository in a uniform format that would more readily allow for
consolidation, the proposed Rule would allow regulators to more easily,
and in a more timely manner, surveil potential manipulative activity
across markets and market participants. The Commission preliminarily
believes that this increased efficiency would enhance the ability of
SRO and Commission staff to detect and investigate manipulative
activity in a more timely manner, whether the activity is occurring on
one market or across markets (or across different product classes).
Timely pursuit of potential violations can be important in, among other
things, seeking to freeze and recover any profits received from illegal
activity.
The Commission also preliminarily believes that the proposed
consolidated audit trail would enhance the ability of SRO and
Commission staff to regulate the trading of NMS securities by requiring
that key pieces of information currently not captured in existing audit
trails be reported to the proposed consolidated audit trail. For
example, proposed Rule 613 would require that the customer that submits
or originates an order be identified in the consolidated audit trail.
In addition, the proposed Rule would require the assignment of unique
identifiers for each order, each customer, and each broker-dealer and
SRO that handles an order. Further, the proposed Rule would greatly
enhance the ability to track an order from the time of order inception
through routing, modification, cancellation, and execution. The
Commission preliminarily believes that this information would allow
regulators to more easily track potential manipulative activity across
markets and market participants, and would place SRO and Commission
staff in a better position to surveil whether exchange rules, as well
as federal securities laws, rules and regulations, are complied with.
The proposal also would require that most of the required audit
trail information be submitted on a real time basis. Most existing
audit trails currently collect information on orders at the end of the
day, or upon request, rather than in real time.\336\ Other order and
execution information, such as EBS data and Rule 17a-25 data, is
provided to the Commission only upon request. The proposed consolidated
audit trail would require that certain information about orders and
executions be provided on a real time basis. The Commission
preliminarily believes that this requirement could significantly
increase the ability of SRO and Commission staff to identify and
investigate manipulative activity in a more timely manner.\337\
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\336\ See supra Sections I.C., I.D., II.A., and V.A.5.
\337\ See supra Section III.D.1.
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The Commission preliminarily believes that the proposal also would
benefit exchanges, FINRA, and Commission staff by improving the ability
of exchanges, FINRA and Commission staff to conduct timely and accurate
trading analysis for market reconstructions, complex enforcement
inquiries or investigations, as well as inspections and examinations.
Today, trading activity is widely dispersed among various market
centers, and one or more related orders for one or more securities or
other related products may be routed to multiple broker-dealers and
more than one exchange, or be executed in the OTC market. Thus, SRO and
Commission regulatory staff investigating potentially illegal behavior
may have to collect information from multiple broker-dealers and then
examine, analyze and reconcile the disparate information provided in
widely divergent formats to accurately reconstruct all trading activity
during a particular time frame in the course of investigating
potentially manipulative activity. Obtaining the necessary order and
execution information and undergoing the necessary analysis to
determine whether any wrongdoing exists based on the information
available today requires substantial investment of time and effort on
behalf
[[Page 32595]]
of regulatory authorities. Under proposed Rule 613, regulatory
authorities would be able to access all information about events in the
life of an order or related orders, and obtain critical information
identifying the customer (or beneficial owner) behind the order(s)
directly from the central repository in a uniform format. Thus, the
Commission preliminarily believes that ability of SRO and Commission
staff to conduct timely and accurate trading analysis for market
reconstructions, complex enforcement inquiries and investigation, as
well as inspections and examinations, would be significantly improved.
The Commission also preliminarily believes that the proposal would
benefit SROs, as well as the NMS for NMS securities, by ultimately
reducing some regulatory costs, which may result in a more effective
re-allocation of overall costs. For example, by providing a more
comprehensive and searchable database, the Commission preliminarily
believes that the consolidated audit trail would significantly decrease
the amount of time invested by SRO staff to determine whether any
illegal activity is occurring either on one market or across markets.
Currently, SRO regulatory staff may need to submit multiple requests to
its members during the course of an investigation into possible illegal
activity, or submit multiple requests to ISG to obtain audit trail
information from other SROs about trading in a particular security, and
then commit significant staff time to collating and analyzing the data
produced. The proposal would benefit the Commission in similar
respects. For example, Commission staff often must submit numerous
requests to members after the Commission receives information from
equity cleared reports in an attempt to identify the ultimate customer
(or beneficial account holder) that entered the order or orders in
question. Substantial Commission staff resources currently are invested
in analyzing the data that is received in response to these requests.
Under proposed Rule 613, SRO regulatory staff would have immediate,
easily searchable access to the consolidated audit trail data through
the central repository for purposes of conducting surveillance,
investigations, and enforcement activities. Commission staff likewise
would have more efficient and timely access for purposes of conducting
risk assessments of referrals received, investigations, and enforcement
activities, and for purposes of conducting market reconstructions or
other analysis. Thus, the Commission preliminarily believes that the
proposal would benefit SRO and Commission staff, as well as the market
for NMS securities as whole, by providing immediately accessible audit
trail information to regulatory staff, which would in turn reduce staff
time and effort that would otherwise be needed to collect and analyze
audit trail information and allow such staff time and effort to be
redirected to more effective uses, possibly even allowing the staff to
engage in more investigations. In other words, if the costs per
investigation decreased because of efficiencies in the proposed
consolidated audit trail information, SRO or Commission staff may be
able to review and investigate a greater amount of suspicious activity.
Likewise, the Commission preliminarily believes that proposed Rule
613 would benefit the exchanges, FINRA, the Commission, and the members
of SROs, as well as investors and the public interest, by reallocating
the overall cost of regulating the markets for NMS securities on an
ongoing basis toward more efficient regulation. For instance, the
Commission preliminarily believes that the proposed consolidated audit
trail would eliminate the need for certain SRO and Commission rules
that currently mandate the collection and provision of information, at
least with respect to NMS securities. As noted above, many exchanges
and FINRA each have their own disparate audit trail rules. Thus, a
member of the various exchanges and FINRA could be subject to the audit
trail rules of, and be required to submit different information to,
more than one exchange and FINRA. The Commission intends that the
proposed consolidated audit trail replace the need to have disparate
SRO audit trail rules. If proposed Rule 613 were adopted, and the
consolidated audit trail was implemented, the Commission preliminarily
believes that the exchanges and FINRA would not need to have separate
and disparate audit trail rules that apply to NMS securities applicable
to their members. Thus, the Commission preliminarily believes that the
proposed consolidated audit trail would ultimately result in the
ability of SROs to repeal their existing audit trail rules because SRO
audit trail requirements would be encompassed within proposed Rule 613.
Similarly, the proposed consolidated audit trail also may render
duplicative and thus unnecessary certain data obtained from the EBS
system pursuant to Rule 17a-25 (and the SRO rules implementing the EBS
system), and from the equity cleared data, at least as it relates to
NMS securities. SRO and Commission staff instead would be able to
access the audit trail information for every order directly from the
central repository.\338\
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\338\ The Commission notes that, if the proposed Rule were
adopted, the SROs would need to consider the continued need for
their existing audit trail rules until such time that their members
begin complying with the requirements of the proposed Rule.
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The Commission requests comment on any ongoing cost savings to SROs
or their members that could be achieved by the proposal. Are there any
other systems or technologies that could be replaced by the proposed
audit trail? Would additional Commission action be required to achieve
cost savings due to redundant rules or systems? Are there any new
systems or technology requirements that could offset these potential
cost savings? To what extent would any cost savings amount to a
reallocation of resources towards more effective or efficient uses?
Please provide specific examples. The Commission also requests comment
as to whether the proposed Rule should require the NMS plan to include
provisions relating to transition from the existing audit trails to the
proposed consolidated audit trail.
As discussed above, the Commission preliminarily believes that the
proposal would significantly enhance the ability of SRO staff to
efficiently and effectively regulate their market and their members,
including detecting and investigating potential manipulative activity.
The Commission also preliminarily believes that the proposed
consolidated audit trail would benefit the Commission in its regulatory
and market analysis efforts. More timely detection and investigation of
potential manipulative activity may lead to greater deterrence of
future illegal activity if potential wrongdoers perceive a greater
chance of regulators identifying their activity in a more timely
fashion. To the extent investors consider the improvement in
regulators' ability to detect and investigate wrongdoing as significant
to their investment decisions, investor trust, which is a component of
investor confidence, is improved and investors may be more willing to
invest in the securities markets.\339\ An increase in investor
participation in the securities markets, at least to the extent that
the increase is allocated efficiently, can potentially benefit the
securities markets as a whole, through better capital formation. Thus,
the Commission preliminarily believes that the proposed consolidated
audit trail
[[Page 32596]]
would benefit the NMS for NMS securities by encouraging more efficient
and potentially a higher level of capital investment.
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\339\ See Guiso, Sapienza, and Zingales, ``Trusting the Stock
Market,'' available at http://ssrn.acom/abstract=811545.
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The Commission requests comment on how the proposal would impact
investor protections and investor confidence. In particular, would the
consolidated audit trail better align investor protections to the
expectations that investors have about their protections? What would be
the economic effect of the potential changes to investor protections or
to better alignment of those protections with investor expectations?
Would any of the anticipated benefits of the proposed Rule be mitigated
if market participants alter their trading behavior, such as by
shifting their trading activity to products or markets that do not
require the capture of customer information to avoid compliance with
the requirements of the proposed Rule? If so, please explain how so,
and what, if any, steps the Commission should take in response.
The Commission also preliminarily believes that proposed Rule 613
would enhance the overall reliability of audit trail data that is
available to the Commission and SRO regulatory staff. Because the
proposed Rule would require that the NMS plan include policies and
procedures, including standards, to be used by the plan processor to
ensure the timeliness, accuracy, and completeness of the audit data
submitted to the central repository, there would be an automatic check
on the incoming audit trail data submitted by exchanges and FINRA, and
their members, for reliability and accuracy. The Commission expects
that these policies and procedures would include validation parameters
that would need to be met before audit trail data would be accepted
into the central repository, and that the central repository would
reject data that did not meet certain validation parameters, and
require resubmission of corrected data. Thus, the Commission
preliminarily believes that the integrity of audit trail information
available to the Commission and to the regulatory staff of the
exchanges and FINRA would be enhanced and safeguarded by the provisions
applicable to the central repository pursuant to proposed Rule 613.
B. Costs
As discussed below, the Commission acknowledges that there likely
would be significant up-front costs to implement the proposal. However,
the Commission preliminarily believes that SRO and Commission staff, as
well as SRO members, would realize other cost savings and benefits.
1. Creation and Filing of NMS Plan
The proposed Rule would require the exchanges and FINRA to jointly
develop and file an NMS plan to create, implement and maintain a
consolidated audit trail that would capture customer and order event
information in real time for all orders in NMS securities, across all
markets, from the time of order inception through execution,
cancellation or modification.\340\ Exchanges and FINRA would be
expected to undertake any joint action necessary to develop and file
the NMS plan, and there would be attendant costs in doing so. For
example, the Commission anticipates that exchange and FINRA staff would
need to meet and draft the required terms and provisions of the NMS
plan.\341\ The Commission preliminarily believes that the existing
exchanges and FINRA would incur an aggregate one-time cost of
approximately $3,503,100 to prepare and file the NMS plan.\342\ Once
exchanges and FINRA have established the NMS plan, the Commission
estimates that, on average, each exchange and FINRA would incur a cost
of $48,384 per year to ensure that the plan is up to date and remains
in compliance with the proposed Rule,\343\ for an estimated aggregate
annual cost of $725,760.
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\340\ See proposed Rule 613(c)(1), (c)(3), (c)(7); see also
supra Sections III.A., III.B., III.D., and V.A.5.
\341\ As discussed above in Section III, these required
provisions include provisions relating to: A governance structure to
ensure the fair representation of the plan sponsors; administration
of the plan, including the selection of the plan processor; the
admission of new sponsors of the NMS plan and the withdrawal of
existing sponsors from the plan; the percentage of votes required by
the plan sponsors to effectuate amendments to the plan; the manner
in which costs of operating the central repository would be
allocated among the exchanges and FINRA, including a provision
addressing the manner in which costs would be allocated to new
sponsors of the plan; the appointment of a Chief Compliance Officer;
the provision stating that by subscribing to and submitting the plan
to the Commission each plan sponsor agrees to enforce compliance by
its members with the provisions of the plan; and the provision
requiring the creation and maintenance by the central repository of
a method of access to the consolidated data that includes search and
reporting functions. See proposed Rules 613(b), 613(e)(3), and
613(g)(3). The NMS plan also would be required to include policies
and procedures, including standards, to be used by the plan
processor to ensure the security and confidentiality of all
information submitted to the central repository; to ensure the
timeliness, accuracy, and completeness of the data provided to the
central repository; to require the rejection of data provided to the
central repository that does not meet the validation parameters set
out in the plan and the re-transmission of corrected data; and to
ensure the accuracy of the processing of the data provided to the
central repository. See proposed Rule 613(e)(4).
\342\ This figure includes internal personnel time and external
legal costs. Commission staff estimates that each exchange and
association would expend (400 Attorney hours x $305 per hour) + (100
Compliance Manager hours x $258 per hour) + (220 Programmer Analyst
hours x $193 per hour) + (120 Business Analyst hours x $194 per
hour) = $213,540. The $305 per-hour figure for an Attorney; the $258
per hour figure for a Compliance Manager; the $193 per hour figure
for a Programmer Analyst; and the $194 per hour figure for a
Business Analysis (Intermediate) are from SIFMA's Management &
Professional Earnings in the Securities Industry 2008, modified by
Commission staff to account for an 1800-hour work-year and
multiplied by 5.35 to account for bonuses, firm size, employee
benefits, and overhead. Commission staff also estimates that each
exchange and association would outsource, on average, 50 hours of
legal time, at an average hourly rate of $400. Thus, the Commission
preliminarily estimates, on average, a total cost of $233,540 per
SRO. See supra Section V.D.1.a. (discussing PRA costs for developing
and filing the NMS plan).
\343\ Commission staff estimates that annually each exchange and
association would expend (64 Attorney hours x $305 per hour) + (64
Compliance Manager hours x $258 per hour) + (64 Programmer Analyst
hours x $193 per hour) = $48,384, to ensure that the NMS plan is up
to date and remains in compliance with the proposed Rule. See supra
note 301.
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In estimating the costs for creation of the NMS plan, the
Commission considered exchange and FINRA staff time necessary for
preparing and filing the plan with the Commission. The Commission also
considered the cost of outsourced legal services. The Commission
requests comment on whether there are additional costs that would
contribute to the expense of creating and filing the NMS plan. Please
describe any such cost in detail and provide an estimate of the costs.
In estimating the ongoing costs of the NMS plan, the Commission
considered exchange and FINRA staff time necessary for periodically
reviewing the plan in light of current market trends and technology.
The Commission requests comment on these estimates and what types of
costs would be incurred to keep the plan up to date.
2. Synchronizing Clocks
The proposed Rule would require each exchange and FINRA, and the
members of each exchange and FINRA, to synchronize its business clocks
that are used for the purpose of recording the date and time of any
reportable event that must be reported pursuant to the proposed Rule to
the time maintained by the National Institute of Standards and
Technology, consistent with industry standards.\344\ As part of the
initial implementation of the consolidated audit trail, the exchanges,
FINRA and their members therefore would have to ensure that their
business clocks are synchronized with the time maintained by the
National Institute of
[[Page 32597]]
Standards and Technology. The proposed Rule also would require that the
NMS plan provide for the annual evaluation of the synchronization time
standard to determine whether it should be shortened, consistent with
industry standards.\345\
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\344\ See proposed Rule 613(d)(1).
\345\ See proposed Rule 613(d)(2).
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The Commission recognizes that the cost to each SRO and member to
synchronize their clocks consistent with the proposed requirements
would vary depending upon the SRO or member's existing systems. The
Commission preliminarily believes, however, that most SROs and their
members currently synchronize their clocks, and that therefore the SROs
and their members would not incur significant costs to comply with this
requirement.\346\ The Commission recognizes that each individual member
or SRO's costs may vary depending upon their current synchronization
practices, their business structure, their order management and trading
systems, and their geographic diversity. The Commission preliminarily
estimates that an SRO or member that would need to make system changes
to comply with the requirement would incur an average one-time initial
cost of approximately $9,650.\347\
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\346\ See CHX Rule 4, Interpretations and Policies .02; FINRA
Rule 7430; NYSE and NYSE Amex Equities Rule 123, Supplementary
Material .23; NYSE and NYSE Amex Equities Rule 132A; and NYSE Arca
Options Rule 6.20.
\347\ Commission staff estimates that, on average, each
exchange, association, and member would expend 50 hours of
information technology time, at a cost of $193 per hour to make
systems changes to comply with the requirement that clocks be
synchronized. This estimate is based on discussions with market
participants.
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The Commission also preliminarily estimates that there would be an
average ongoing annual cost of approximately $11,580 to each exchange,
FINRA, and member to synchronize their business clocks to the time
maintained by the National Institute of Standards and Technology,
consistent with industry standards.\348\ Further, the Commission
preliminarily estimates that there would be an average cost to
exchanges, FINRA and their members of approximately $6,192 per SRO or
member to annually evaluate the synchronization time standards to
determine whether it should be shortened, consistent with industry
standards.\349\
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\348\ Commission staff estimates that each exchange, association
and member would expend approximately five hours of information
technology time, per month, at $193 per hour. This estimate is based
on discussions with industry participants.
\349\ This estimate assumes that each SRO or member would expend
(16 Programmer Analyst hours x $193 per hour) + (16 Business Analyst
hours x $194 per hour) = $6,192 to carry out this annual evaluation.
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As stated above, the Commission preliminarily believes that the
costs to the SROs and their members associated with synchronizing their
clocks would not be significant because most SROs and their members
currently synchronize their clocks. The Commission requests comments on
whether commenters agree. If not, what costs would be incurred? Please
be specific as to the type of changes necessary and the costs of making
them. Further, the proposed Rule would require that all SROs and their
members synchronize to same time standard and to the same level of
accuracy. The Commission requests comment on its estimate of the cost
to SROs and their members of initializing synchronizing business
clocks, the ongoing costs for maintaining accurate synchronization, and
the costs associated with annual evaluation of the synchronization time
standard. Would SROs or their members incur costs, and if so, what
types of costs?
3. Costs To Provide Information
As discussed above in Section V.A.5, the Commission preliminarily
believes that the proposed Rule would require the collection and
reporting on a real time basis of some information that national
securities exchanges and national securities associations already
record to operate their business, and are required to maintain in
compliance with Section 17(a) of the Exchange Act and Rule 17a-1
thereunder.\350\ However, the proposed Rule would require each SRO to
collect and report additional and more detailed information, and to
report the information to the central repository in real time in a
specified format. Based on discussions with SROs, the Commission
anticipates that exchanges would need to enhance or replace their
current systems to be able to comply with the proposed information
collection and reporting requirements of the proposed Rule.
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\350\ 15 U.S.C. 78q(a) et seq.; 17 CFR 240.17a-1. Rule 17a-1
requires an exchange or association to keep and preserve at least
one record of all documents or other records that shall be received
by it in the course of its business as such and in the conduct of
its self-regulatory activity. This would include records of the
receipt of all orders entered into their systems, as well as records
of the routing, modification, cancellation, and execution of those
orders. The Commission understands that SROs have automated this
process and thus keep these records in electronic format.
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Likewise, the Commission preliminarily believes the proposed Rule
would require the collection of much of the information that registered
broker-dealers already maintain in compliance with existing
regulations.\351\ The proposed Rule, however, would require members to
collect additional information for each order and, in addition to the
new information, the members also would be required to report most of
the information on a real time basis to the central repository in a
specified uniform format. Based on discussions with members, the
Commission anticipates that the SRO members would need to enhance or
replace their current order handling, trading and other systems to be
able to collect and report the required order and reportable event
information to the central repository as required by the proposed Rule.
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\351\ See supra notes 317 to 319 and accompanying text.
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The Commission recognizes that the extent to which a particular SRO
or member would need to make systems changes would differ depending
upon the SRO's market structure (e.g., floor vs. electronic) and
systems, or the member's current business operations and systems. The
Commission preliminarily estimates that the average one-time, initial
cost to exchanges and FINRA to put in place the systems necessary to
identify, collect and transmit the consolidated audit trail information
to the central repository would total approximately $5 million per
SRO,\352\ for an aggregate estimated cost of $75 million for all SROs.
In estimating this cost, the Commission has considered SRO staff time
necessary to build new systems or enhance existing systems to comply
with the proposed Rule.\353\ In addition, the Commission estimated
costs for system hardware, software, and other materials.\354\ What
other types of costs
[[Page 32598]]
might SROs incur? Please be specific in your response.
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\352\ The Commission based this estimated cost on the
Commission's previous experience with, and burden estimates for, SRO
systems changes and discussions with market participants. See
Regulation NMS Reproposing Release, supra note 306, at 77480
(discussing costs of implementing Rule 611 of Regulation NMS).
Although the Commission recognizes that the substance of Rule 611 is
not the same as the proposed Rule, the Commission preliminarily
believes that the scope of systems changes would be comparable.
\353\ Commission staff estimates that each exchange and
association would expend (100 Attorney hours x $305 per hour) + (80
Compliance Manager hours x $258 per hour) + 1,960 Programmer Analyst
hours x $193 per hour) + 60 Business Analyst hours x $194) =
$441,060 to develop and implement the systems needed to capture the
required information and transmit it. In addition, the Commission
estimates that each exchange and association would expend 40 hours
of outsourced legal time at an average rate of $400 per hour. See
supra note 305.
\354\ Commission staff estimates that the cost for system
hardware, software, and other materials would be $4,542,940. See
supra note 306 and accompanying text.
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Once an SRO has implemented the changes necessary to collect and
transmit the required information to the central repository as required
by the proposed Rule, the Commission estimates that each SRO would
incur, on average, an annual ongoing cost of $2.5 million to ensure
compliance with the proposed Rule,\355\ for an estimated ongoing annual
aggregate cost of $37.5 million for all SROs.
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\355\ Commission staff estimates that each exchange and
association would expend (1,500 Attorney hours x $305 per hour) +
(1,600 Compliance Manager hours x $258 per hour) + (1,375 Programmer
Analyst hours x $193 per hour) + (500 Business Analyst hours x $194
per hour) to ensure that the systems technology is up to date and
remains in compliance with the proposed Rule, for a total of
$1,250,675. In addition, Commission staff estimates that each
exchange and association would expend approximately $1.25 million on
system hardware, software, connectivity and other materials. These
estimates reflect the preliminary view that ongoing costs to
maintain compliance with the proposed Rule would be half of the
initial costs. See supra notes 307 and 308.
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The Commission understands that many members, particularly smaller
members, currently rely on third parties to report information required
to be reported pursuant to SRO audit trail or other rules. For example,
a member that is an introducing broker who sends all of its customer
order flow to a clearing broker currently may rely on that clearing
broker for reporting purposes. The Commission preliminarily believes
that these members would not undertake a fundamental restructuring of
their business to comply with the proposed Rule. Instead, they might
continue to rely on their clearing broker-dealer, or they might look
for the ability to purchase a standardized software product provided by
a third party that would provide the functionality to electronically
capture the required information and transmit it to the central
repository in real time. The costs of this approach are likely to be
significantly lower than the costs to a member that enhances its own
systems, or creates new systems, to comply with the proposed
requirements to report information to the central repository. The
Commission estimates that there are approximately 3,006 of these types
of members, and that the average cost to such members to compensate a
third party, whether a clearing broker-dealer or other third party, for
software that would provide the necessary functionality to
electronically capture the required information and transmit it to the
central repository would be approximately $50,000 per member.\356\ In
addition, the Commission estimates that, on average, each member would
incur a one-time cost of $35,870 to incorporate the new functionality
into its existing systems to ensure compliance with the proposed
Rule.\357\ Thus, the Commission preliminarily estimates that each of
these members would incur, on average, a one-time cost of $85,870, for
an estimated aggregate cost of $258,125,220.
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\356\ See supra note 328. The Commission based this estimated
cost on the Commission's previous experience with, and burden
estimates for, broker-dealer systems changes. See Regulation NMS
Reproposing Release, supra note 306, at 77480 (discussing costs of
implementing Rule 611 of Regulation NMS). Although the Commission
recognizes that the substance of Rule 611 is not the same as the
proposed Rule, the Commission preliminarily believes that the scope
of systems changes would be comparable.
\357\ Commission staff estimates that annually each of these
types of members would expend (50 Attorney hours x $305 per hour) +
(50 Compliance Manager hours x $258 per hour) + (40 Information
Analyst hours x $193 per hour) = $35,870 to incorporate the new
functionality into its existing systems.
These costs would include any systems or other changes necessary
to obtain the required customer information, including the identity
of the beneficial owner, and electronically storing it for
transmittal to the central repository with the order information.
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The Commission also preliminarily estimates that each of these
members would continue to incur, on average, annual costs of $66,512 to
ensure continued compliance with the proposed Rule.\358\
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\358\ This estimate is based on a cost of $50,000 per year to
compensate a third party for the functionality to capture the
required information and transmit it to the central repository, and
a cost of $16,512 for personnel time to oversee compliance with the
proposed Rule (64 hours Compliance Manager x $258 per hour). See
supra note 330.
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Do commenters believe that smaller members would likely rely on
third parties to provide a functionality that would provide required
data to the central repository? Why or why not? Would it be more cost
effective for a small member to enhance existing systems or create new
systems to comply with the proposed Rule? Why or why not? What would be
the costs associated with each approach? Should members that currently
rely on another party to report, such as their clearing broker, be able
to have their clearing firms report on their behalf? Why or why not?
How would allowing third-party reporting impact the ability to report
data in real time? Would the manner in which these members currently
maintain customer information create practical difficulties for
providing the beneficial ownership information, or additional burdens
that have not been taken into account in estimating costs? For example,
is customer information stored electronically? What is the impact of
the manner in which this information is currently stored on the
Commission's cost estimates?
The Commission preliminarily estimates that there are 1,114 members
that would undertake their own development changes to implement the
proposed Rule.\359\ The Commission preliminarily estimates that the
average one-time, initial cost to these members for development,
including programming and testing of the systems necessary to identify,
collect and transmit the consolidated audit trail information to the
central repository, would be approximately $3 million per member,\360\
for an estimated aggregate cost of $3,342,000,000. This number would
likely overestimate the costs for some of these members and
underestimate it for others. For example, it likely overestimates the
cost for ATSs as opposed to broker-dealers that have a customer and
proprietary, or market-making, business, in part because of the
narrower business focus of some ATSs. The Commission recognizes that
some of these members may contract with one or more outside vendors to
provide certain front-end order management systems. The third-party
vendor may make changes to its systems to permit the members that use
the system to capture and provide the required information to the
central repository. Likewise, some of these members may contract with
outside vendors to provide back-office functionality. These third-party
vendors may make changes to their systems to permit the members that
use the systems to capture and provide the required information to the
central repository. The cost of these changes may be shared by the
various members that use the systems, and thus may result in a reduced
cost to an individual
[[Page 32599]]
member to implement changes to its own systems to comply with the
requirements of the proposed consolidated audit trail.
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\359\ See supra Section V.D.2 and note 320.
\360\ Commission staff estimates that each member would expend
(1,240 Attorney hours x $305 per hour) + (1,540 Compliance Manager
hours x $258 per hour) + (2,750 Programmer Analyst hours x $193 per
hour) + (1,000 Business Analyst hours x $194 per hour) = $1,500,270
to develop and implement the systems needed to capture the required
information and transmit it. In addition, the Commission estimates
that the cost for system hardware, software, and other materials
would be approximately $1.5 million. This estimate is based on the
Commission's previous experience with, and burden estimates for,
broker-dealer systems changes. See Regulation NMS Reproposing
Release, supra note 306, at 77480 (discussing cost estimates for
implementing Rule 611 of Regulation NMS). Although the Commission
recognizes that the substance of Rule 611 is not the same as the
proposed Rule, the Commission preliminarily believes that the scope
of systems changes would be comparable. These costs would include
any systems or other changes necessary to obtain the required
customer information, including the identity of the beneficial
owner, and electronically storing it for transmittal to the central
repository with the order information.
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The Commission requests comment on this estimate. Specifically,
what types of costs would members incur building new systems, or
enhancing existing systems, to comply with the proposed Rule? Would
members need to expand their capacity as part of any systems upgrades?
What would be the costs associated with this? Would the manner in which
these members currently maintain customer information create practical
difficulties for providing the beneficial ownership information, or
additional burdens that have not been taken into account in estimating
costs? For example, is customer information stored electronically? What
is the impact of the manner in which this information is currently
stored on the Commission's cost estimates?
Once these members have largely implemented the changes necessary
to collect and report the required order and reportable event
information to the central repository as required by the proposed Rule,
the Commission estimates that each such member would incur, on average,
an annual ongoing cost of approximately $1.5 million,\361\ for an
estimated aggregate ongoing cost of $1,671,000,000. These estimates
would cover the costs associated with continued compliance with the
proposed Rule.\362\
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\361\ Commission staff estimates that each member would expend
(800 Attorney hours x $305 per hour) + (1,000 Compliance Manager
hours x $258 per hour) + (500 Programmer Analyst hours x $193 per
hour) + (750 Business Analyst hours x $194 per hour) = $744,000 to
ensure that the systems technology is up to date and remains in
compliance with the proposed Rule. In addition, Commission staff
estimates that each member would expend approximately $756,000 on
system hardware, software, connectivity and other materials. These
estimates reflect the preliminary view that ongoing costs to
maintain compliance with the proposed Rule would be half of the
initial estimated costs.
\362\ See supra Section V.D.2.
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The Commission requests comment on what ongoing costs SROs and
their members would incur to continue to collect and report the
required information in compliance with the proposed Rule. What types
of costs would be included? Are there differences in the costs that
SROs and their members would incur? Why or why not?
The proposal would require the transmission of information in real
time to the central repository. The Commission preliminarily believes
that this approach would have greater benefits and would be lower cost
than an alternative of transmitting all reports in batch mode. Real
time submission could simply require a ``drop copy'' of a reportable
event be sent to the central repository at the same time that the
reportable event is otherwise occurring. Batching, however, would
require the build up of reports to be sent periodically, and the amount
of data sent in a batch could be significantly larger than the data
sent in real time. The Commission requests comment on the technology
requirements and other costs of real time transmission of information
versus periodically batching the reports. Would real time reporting be
more or less costly than batch reporting? Please explain with
specificity why or why not and provide cost estimates. If real time
reporting would be more expensive, are the greater costs justified by
the benefits of real time reporting described above? If batch reporting
is the better alternative, what should be the frequency of the batch
reporting and why? Does the answer depend on the type of security? The
Commission also requests comment on what types of systems changes SROs
and members would need to make to implement the proposed Rule and NMS
plan requirements, and the attendant costs. What specific types or
items of information, if any, would be required to be reported to the
central repository by a member that would not already be collected and
maintained in an automated format?
4. Cost of Enhanced Surveillance Systems
Pursuant to the proposed Rule, exchanges and FINRA also would be
required to develop and implement a surveillance system, or enhance
existing surveillance systems, reasonably designed to make use of the
consolidated information collected through the proposed consolidated
audit trail.\363\ The Commission preliminarily estimates that the
average one-time cost to implement this requirement would be
approximately $10 million for each exchange and FINRA, for an estimated
aggregate cost of $150 million.\364\ The Commission also estimates, on
average, ongoing annual costs associated with the enhanced surveillance
would be approximately $2,610,600,\365\ for an estimated aggregate,
ongoing cost of $39,159,000. Based on discussions with market
participants, the Commission recognizes that these estimated costs may
vary, perhaps significantly, based on the market model utilized by a
particular SRO. For certain SROs, these figures may overestimate the
costs associated with developing or enhancing surveillance systems,
while for others, it may underestimate the costs. The Commission
requests comment on whether these figures accurately estimate the costs
for developing or enhancing surveillance systems to comply with the
proposed Rule for the SROs. Would these figures be lower or higher for
SROs whose trading systems are fully electronic? Would the cost
estimates be higher or lower for those SROs that have a trading floor?
What other considerations would impact individual SRO costs? Please be
specific in your response.
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\363\ See proposed Rule 613(f).
\364\ This estimate is based on discussions with market
participants. This estimate does not separately break out personnel
time versus system costs.
\365\ Commission staff estimates that each member would expend
(3,600 Senior Compliance Examiner hours x $212 per hour) and (1,800
Information Analyst hours x $193 per hour) to operate and monitor
the enhanced surveillance systems and carry out surveillance
functions. In addition, Commission staff estimates that each member
would expend approximately $1.5 million on system hardware,
software, connectivity and other technology per year on an on-going
basis for this purpose. These estimates are based on discussions
with a market participant.
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The Commission also requests comment on whether SROs would be able
to enhance their existing surveillance and regulation to make use of
the proposed consolidated information or would they need to develop new
surveillance systems to comply with the proposed Rule? How would SROs
enhance their current surveillance systems? What would be the costs
associated with updating current systems as opposed to developing new
surveillance systems? Would it be more cost efficient to establish
coordinated surveillance across exchanges and FINRA, rather than having
each SRO be responsible for surveillance on its own market using the
consolidated data? What would be the costs associated with developing
consolidated cross-market surveillance?
5. Central Repository System
The central repository would be responsible for the receipt,
consolidation, and retention of all the data required to be submitted
by the exchanges and FINRA, and their members. The proposed Rule also
would require that the central repository collect and retain on a
current and continuous basis the NBBO for each NMS security,
transaction reports reported pursuant to an effective transaction
reporting plan, and last sale reports reported pursuant to the OPRA
Plan. The central repository would be
[[Page 32600]]
required to maintain the NBBO and transaction data in a format
compatible with the order and event information collected pursuant to
the proposed Rule. Further, the central repository would be required to
retain the information collected pursuant to paragraphs (c)(7) and
(e)(5) of the proposed Rule in a convenient and usable standard
electronic data format that is directly available and searchable
electronically without any manual intervention for a period of not less
than five years. The information shall be available immediately, or if
immediate availability cannot reasonably and practically be achieved,
any search query must begin operating on the data not later than one
hour after the search query is made.\366\
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\366\ See proposed Rule 613(e)(6).
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The central repository thus would need its own system(s) to
receive, consolidate, and retain the electronic data received from the
plan sponsors and their members, as well as to collect and retain the
NBBO and last sale data. The system would be required to be accessible
and searchable by the sponsors and the Commission for regulatory
purposes,\367\ with validation parameters allowing the central
repository to automatically check the accuracy and the completeness of
the data submitted, and reject data not conforming to these parameters.
It is anticipated that the costs of development and operation of the
central repository would be shared among the plan sponsors. The
Commission preliminarily estimates a one-time initial cost to create
the central repository, its systems and structure, of approximately
$120 million for an average cost of approximately $8 million per plan
sponsor.\368\
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\367\ The proposed Rule would require that the central processor
create and maintain a method of access to the consolidated data. See
proposed Rule 613(e)(3). The Rule requires that this method of
access would be designed to include search and reporting functions
to optimize the use of the consolidated data. The cost of creating a
method of access to the consolidated audit trail data is included
within the overall systems cost estimate.
\368\ Commission staff estimates that each exchange and
association would expend (3,000 Attorney hours x $305 per hour) +
(4,000 Compliance Manager hours x $258 per hour) + (7,500 Programmer
Analyst hours x $193 per hour) + (3,000 Business Analyst hours x
$194 per hour) = $3,976,500 to create the central repository. In
addition, the Commission estimates that the cost per exchange or
association for system hardware, software, and other materials would
be approximately $4 million. See supra Section V.D.1.d. and note
309.
This estimate includes the estimated costs that each exchange
and association would incur for software and hardware costs related
to systems development. This cost estimate also would encompass (1)
costs related to engaging in an analysis and formal bidding process
to choose the plan processor, and (2) any search undertaken to hire
a CCO. See proposed Rule 613(a)(3)(i) (the plan sponsors would be
required to select a person to act as a plan processor for the
central repository no later than two months after the effectiveness
of the NMS plan) and 613(b)(5) (the plan sponsors would be required
to appoint a CCO to regularly review the operation of the central
repository to assure its continued effectiveness in light of market
and technological developments, and make any appropriate
recommendations for enhancements to the nature of the information
collected and the manner in which the information is processed).
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Does this estimate accurately reflect SRO staff time needed to
create the central repository as well as the costs for any hardware,
software and other materials required? Are there other cost components
to creating the central repository the Commission should consider? Is
the creation of a central repository as described in the proposed Rule
for collection and consolidation of data the most cost effective way to
achieve the objective of creation of a consolidated audit trail? Are
there other alternatives the Commission should consider? Please
describe the costs associated with any alternatives described.
Once the plan sponsors have established the systems necessary for
the central repository to receive, consolidate, and retain the required
information, the Commission estimates that ongoing annual costs to
operate the central repository would be approximately $100
million,\369\ which would be approximately $6.6 million per year per
plan sponsor. The Commission also estimates that each plan sponsor
would incur, on average, ongoing costs of $48,384 per year for actions
taken to review the operation and administration of the central
repository.\370\ In addition, the Commission estimates that the central
repository would incur an ongoing cost of $1,370 per year to purchase
the NBBO and last sale data feeds from the SIPs.\371\
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\369\ See supra Section V.D.1.d. This cost estimate includes
ongoing costs for operating the central repository, including the
cost of systems and connectivity upgrades or changes necessary to
receive, consolidate, and retain and store the reported order
information from SROs and their members; the cost, including storage
costs, of collecting and maintaining the NBBO and transaction data
in a format compatible with the order and event information
collected pursuant to the proposed Rule; the cost of monitoring the
required validation parameters; the cost of compensating the plan
processor; and an ongoing annual cost of $703,800 to compensate the
CCO. See supra note 312.
\370\ Commission staff estimates that annually each exchange and
association would expend (64 Attorney hours x $305 per hour) + (64
Compliance Manager hours x $258 per hour) + (64 Programmer Analyst
hours x $193 per hour) = $48,384 to ensure and review the operation
and administration of the central repository. See supra note 343 and
accompanying text.
\371\ See supra Section V.D.1.e.
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The Commission request comment on these estimated costs. Does this
estimate accurately reflect the cost of storing data in a convenient
and usable standard electronic data format that is directly available
and searchable, without any manual intervention, for a period of not
less than 5 years? Would these costs estimates change if the scope of
the consolidated audit trail were expanded to include equity securities
that are not NMS securities; corporate bonds, municipal bonds, and
asset-backed securities and other debt instruments; credit default
swaps, equity swaps, and other security-based swaps? What systems or
other changes would be necessary to accommodate these other products?
How would those changes impact costs?
6. SRO Rule Filings
The exchanges and FINRA also would be required to file proposed
rule changes to implement the provisions of the NMS plan with respect
to their members.\372\ The Commission notes that the exchanges and
FINRA would be able to use the NMS plan as a roadmap to draft the
content of their required proposed rule changes. The Commission also
notes that the rule filing format and process is not new to the
exchanges or to FINRA.\373\ The Commission estimates that the aggregate
cost of each SRO filing a proposed rule change to implement the NMS
plan to be approximately $590,175.\374\
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\372\ See proposed Rule 613(g)(1).
\373\ The Commission notes that, for its 2009 fiscal year
(October 1, 2008 to September 30, 2009), the then existing twelve
exchanges and FINRA filed approximately 1,308 proposed rule changes
in the aggregate pursuant to Section 19(b) and Rule 19b-4
thereunder.
\374\ This figure was calculated as follows: (129 Attorney hours
x $305) = $39,345 x 15 SROs = $590,175. Commission staff estimates
that each exchange and association would expend approximately 129
hours of legal time x $305 to prepare and file a complex rule
change. See Securities Exchange Act Release No. 50486 (October 4,
2004), 69 FR 60287 (October 8, 2004) (File No. S7-18-04). The $305
per-hour figure for an attorney is from SIFMA's Management &
Professional Earnings in the Securities Industry 2008, modified by
Commission staff to account for an 1800-hour work-year and
multiplied by 5.35 to account for bonuses, firm size, employee
benefits, and overhead. See Securities Exchange Act Release No.
59748 (April 10, 2009), 74 FR 18042, 18093 (April 20, 2009) (S7-08-
09) (noting the Commission's modification to the $305 per hour
figure for an attorney).
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7. Expansion of the Proposed Consolidated Audit Trail
The proposed Rule would require the plan sponsors to jointly
provide to the Commission a report outlining how the sponsors would
incorporate into the consolidated audit trail information with respect
to: (1) Equity securities that
[[Page 32601]]
are not NMS securities; (2) debt securities; and (3) primary market
transactions in equity securities that are not NMS securities, in NMS
stocks, and in debt securities. The sponsors would be required to
address, among other things, details for each order and reportable
events that they would recommend requiring to be provided; which market
participants would be required to provide the data; an implementation
schedule; and a cost estimate. Thus, the exchanges and FINRA would need
to, among other things, undertake an analysis of technological and
computer system acquisitions and upgrades that would be required to
incorporate such an expansion. The Commission preliminarily estimates
that the one-time cost to the exchanges and FINRA to create and file
with the Commission a report for expanding the scope of the
consolidated audit trail would be approximately $1,751,550 for a one-
time cost of $116,770 per SRO.\375\
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\375\ Commission staff estimates that each member would expend
(200 Attorney hours x $305 per hour) + (50 Compliance Manager hours
x $258 per hour) + (110 Programmer Analyst hours x $193 per hour) +
(60 Business Analyst hours x $194 per hour) + (25 Outsourced Legal
Counsel hours x $400 per hour) = $116,770 to create and file with
the Commission a report for expanding the scope of the consolidated
audit trail. See supra Section V.D.1.b and note 302.
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Does this estimate accurately reflect the expenses, including SRO
staff time and systems analyses, which SROs would incur in preparing
the required report? Are there other costs components that should be
considered in determining costs associated with preparing the required
report? Please provide details on any additional costs that should be
considered.
8. Other Costs
Proposed Rule 613 would specifically require, for the receipt or
origination of each order, information to be reported to the central
repository with respect to the ultimate customer that generates the
order. Specifically, members would be required to report to the central
repository information about the beneficial owner of the account
originating the order and the person exercising investment discretion
for the account originating the order, if different from the beneficial
owner, and each customer would be identified by a unique customer
identifier. Thus, information about ``live'' orders, as well as overall
order and execution information for a particular customer, would be
available in the central repository. In recognition of the sensitivity
of this data, the proposed Rule requires the NMS Plan to include
policies and procedures, including standards, to be used by the plan
processor to ensure the security and confidentiality of all information
submitted to, and maintained by, the central repository.
However, a potential cost could be incurred if the security and
confidentiality of the information submitted to the central repository
is breached, either by malfeasance or accident. In either case, if
identifying information about customers and their trading is made
public--contrary to the expectations and intentions of the customers--
the Commission preliminarily believes that this may have a negative
effect on the securities markets. Specifically, investors may be less
willing to allocate their capital to the securities markets if their
expectation that their personal identifying and trading information
will be adequately protected by the central repository is not met.
Under these circumstances, there could be a reduction in the capital
invested in the markets for NMS securities by investors, to the
detriment of the U.S. securities markets overall.
Proposed Rule 613 also would require that the NMS plan include
policies and procedures, including standards, for the plan processor to
use to ensure the integrity of the information submitted to the central
repository. Specifically, the proposed Rule requires that the policies
and procedures be designed to ensure the timeliness, accuracy, and
completeness of the data provided to the central repository by the
exchanges, FINRA and their members, and to require the rejection of
data provided if the data does not meet validation parameters, and the
re-transmission of such data. The Commission notes that, despite such
safeguards for ensuring the integrity of the audit trail data, the
information submitted by the exchanges, FINRA and their members could
be inaccurate, either due to system or human error. If the reliability
of the data is compromised, this could reduce the usefulness of the
consolidated audit trail data for regulatory purposes.
Are there any other non-tangible costs associated with potential
breaches of the integrity or confidentiality of the data required to be
submitted to the central repository that the Commission should
consider?
9. Total Costs
Based on the assumptions and resulting estimated costs discussed
above, the Commission preliminarily estimates the initial aggregate
cost the exchanges and FINRA would incur to comply with the proposed
Rule, other than costs related to creating and operating the central
repository, would be approximately $231 million,\376\ and ongoing
aggregate annual costs would be approximately $77.7 million.\377\ In
addition, the exchanges and FINRA would incur an initial aggregate cost
of approximately $120 million to set up the central repository,\378\
with ongoing annual costs to operate the central repository of
approximately $101 million.\379\ For SRO members that would make
changes to their own order management and trading systems to comply
with the proposed Rule,\380\ we estimate the initial aggregate one-time
cost for implementation of the proposed Rule would be approximately
$3.4 billion \381\ and aggregate ongoing annual costs would be
approximately $1.7 billion.\382\ For SRO members that are
[[Page 32602]]
likely to rely on a third party to comply with the proposed Rule (such
as their clearing broker),\383\ we estimate the initial aggregate one-
time cost for implementation of the proposed Rule would be
approximately $287 million \384\ and ongoing annual costs would be
approximately $253 million.\385\ Therefore, for all SROs and members,
we estimate that the total one-time aggregate cost to implement the
proposed Rule would be approximately $4 billion and the total ongoing
aggregate annual costs would be approximately $2.1 billion.
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\376\ This aggregate cost estimate includes the aggregate one-
time cost of preparing and filing the NMS plan ($3,503,100); the
aggregate average one-time cost for each exchange and FINRA to
synchronize clocks consistent with the proposed requirements
($144,750); the aggregate average one-time cost for each exchange
and FINRA to identify, collect and transmit the consolidated audit
trail information to the central repository ($75 million); the
aggregate average one-time cost for each exchange and FINRA to
develop and implement surveillance systems, or enhance existing
surveillance systems ($150 million); the aggregate one-time cost for
each exchange and FINRA to file proposed rule changes to implement
the provisions of the NMS plan with respect to their members
($590,175); and the aggregate one-time cost to the exchanges and
FINRA of jointly providing to the Commission a report outlining how
the exchanges and FINRA would expand the scope of the consolidated
audit trail ($1,751,550).
\377\ This aggregate cost estimate includes the aggregate
average ongoing annual cost to ensure that the plan is up to date
and remains in compliance with the proposed Rule ($725,760); the
aggregate average ongoing annual cost to synchronize clocks
consistent with industry standards ($173,700); the aggregate average
ongoing annual cost to evaluate the synchronization standards
($92,880); the aggregate average ongoing annual cost to ensure that
each exchange and FINRA is providing information in compliance with
the proposed Rule ($37.5 million); and the aggregate average ongoing
annual cost associated with enhanced surveillance ($39,159,000).
\378\ See supra note 368.
\379\ See supra notes 369 to 371 and accompanying text.
\380\ We preliminarily estimate there are 1,114 of these broker-
dealers, including all clearing firms and alternative trading
systems. See supra note 320.
\381\ This aggregate cost estimate includes the aggregate
average one-time cost for such members to identify, collect and
transmit the consolidated audit trail information to the central
repository ($3,342,000,000); and the aggregate average initial cost
for such members to synchronize clocks consistent with the proposed
requirements ($10,750,100).
\382\ This aggregate cost estimate includes the aggregate
average ongoing annual cost for such members to identify, collect
and transmit the consolidated audit trail information to the central
repository ($1,671,000,000); and the aggregate average ongoing
annual cost for such members to annually evaluate the
synchronization time standards and perform any necessary
synchronization adjustments ($19,798,008).
\383\ We preliminarily estimate there are 3,006 of these broker-
dealers, mainly including non-clearing broker-dealers. See supra
note 327.
\384\ This aggregate cost estimate includes the aggregate
average initial cost for such members to identify, collect and
transmit the consolidated audit trail information to the central
repository ($258,125,220); and the aggregate average initial cost
for such members to synchronize clocks consistent with the proposed
requirements ($29,007,900).
\385\ This aggregate cost estimate includes the aggregate
average ongoing annual cost for such members to identify, collect
and transmit the consolidated audit trail information to the central
repository ($199,935,072); and the aggregate average ongoing annual
cost for such members to annually evaluate the synchronization time
standards and perform any necessary synchronization adjustments
($53,422,632).
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C. Request for Comment
The Commission requests general comment on the costs and benefits
of proposed Rule 613 of Regulation NMS discussed above, as well as any
costs and benefits not already described which could result from the
proposed Rule. The Commission also requests data to quantify any
potential costs or benefits.
The Commission requests comment on what, if any, would be the
impact of the proposed Rule on competition among the exchanges and
other non-exchange market centers? If commenters believe there would be
an impact on competition, please explain and quantify the costs or
benefits of such impact. If commenters believe that there would be a
cost, what steps could the Commission take to mitigate such costs?
The Commission also requests comment on whether the requirements of
the proposed Rule, such as the requirement to provide detailed
information to the central repository on a real time basis, would have
an impact on any form of legal trading activity engaged in by market
participants, or the speed with which trading occurs. For example,
would requiring additional information to be attached to an order when
the order is routed from one member or exchange to another--such as the
unique order identifier--impact the speed with which routing and
trading occurs? If not, why not? If so, why? If there would be an
impact, do commenters believe that the impact would be negative? Why or
why not? Also, would the requirement to provide customer and order
information to the central repository in real time impact market
participant trading activity? If so, how so? If commenters believe the
impact would provide a benefit, please explain and quantify. If
commenters believe that the impact would impose a cost, please explain
and quantify. For example, would market participants be hesitant to
engage in certain legal trading activity because of a concern about
providing customer and order information in real time? Would market
participants shift their trading activity to products or markets that
do not require the capture of customer information to avoid compliance
with this requirement of the proposed Rule? If so, how should the
Commission address those concerns? Please be specific in your
responses. The Commission requests comment on any other changes to
behavior that commenters believe may result from application of the
proposed Rule. For example, do commenters believe that the proposal
would cause illegal trading activity to shift to products or markets
not covered by the proposed Rule? If so, should that impact the scope
of the proposed Rule? If so, how so? If not, why not?
VII. Consideration of Burden on Competition and Promotion of
Efficiency, Competition, and Capital Formation
Section 3(f) of the Exchange Act requires the Commission, whenever
it engages in rulemaking and is required to consider or determine
whether an action is necessary or appropriate in the public interest,
to consider, in addition to the protection of investors, whether the
action would promote efficiency, competition, and capital
formation.\386\ In addition, Section 23(a)(2) of the Exchange Act
requires the Commission, when making rules under the Exchange Act, to
consider the impact such rules would have on competition.\387\ Exchange
Act Section 23(a)(2) prohibits the Commission from adopting any rule
that would impose a burden on competition not necessary or appropriate
in furtherance of the purposes of the Exchange Act. As discussed below,
the Commission's preliminary view is that the proposed Rule should
promote efficiency, competition, and capital formation.
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\386\ 15 U.S.C. 78c(f).
\387\ 15 U.S.C. 78w(a)(2).
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Section 11A(a)(3)(B) of the Exchange Act provides in part that the
Commission may, by rule, require SROs to act jointly with respect to
matters as to which they share authority under the Exchange Act in
regulating a national market system for securities.\388\ Proposed Rule
613 would require all national securities exchanges and national
securities associations to jointly submit to the Commission an NMS plan
to create, implement, and maintain a consolidated audit trail for NMS
securities. Under the proposal, pursuant to the NMS plan, and SRO rules
adopted thereunder to implement the plan, national securities exchanges
and national securities associations, as well as their members, would
be required to provide detailed order and execution data to a central
repository to populate a consolidated audit trail.\389\
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\388\ See Section 11A(a)(3)(B) of the Exchange Act, 15 U.S.C.
78k-1(a)(3)(B).
\389\ See supra Section III.D. for a detailed description of the
required data.
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A. Competition
The Commission considered the impact of proposed Rule 613 on the
national securities exchanges, national securities associations, and
their members that trade NMS securities. The Commission begins its
consideration of potential competitive impacts with observations of the
current structure of the markets for trading NMS securities.
The industry for the trading of NMS securities is a competitive
one, with reasonably low barriers to entry and significant competition
for order flow. The intensity of competition across trading platforms
that trade NMS securities has increased dramatically in the past decade
as a result of technological advances and regulatory changes. This
increase in competition has resulted in decreases in market
concentration, more competition among market centers, a proliferation
of trading platforms competing for order flow, and decreases in trading
fees.
In addition, the Commission, within the past five years, has
approved applications by BATS,\390\ Direct
[[Page 32603]]
Edge,\391\ Nasdaq,\392\ and C2 \393\ to become registered as national
securities exchanges for trading equities, approved proposed rule
changes by two existing exchanges--the ISE \394\ and CBOE \395\--to add
cash equity trading facilities to their existing options business; and
approved proposed rule changes by two existing exchanges--Nasdaq and
BATS--to add options trading facilities to their existing cash equities
business.\396\
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\390\ See Securities Exchange Act Release No. 58375 (August 18,
2008), 73 FR 49498 (August 21, 2008) (order approving BATS
Exchange's application for registration as a national securities
exchange).
\391\ See Securities Exchange Act Release No. 61698 (March 12,
2010), 75 FR 13151 (March 18, 2010) (order approving EDGA Exchange
and EDGX Exchange's applications for registration as national
securities exchanges).
\392\ See Securities Exchange Act Release No. 53128 (January 13,
2006), 71 FR 3550 (January 23, 2006) (File No. 10-131) (order
approving Nasdaq's application for registration as a national
securities exchange).
\393\ See Securities Exchange Act Release No. 61152 (December
10, 2009), 74 FR 66699 (December 16, 2009) (order approving C2
Options Exchange's application for registration as a national
securities exchange).
\394\ See Securities Exchange Act Release No. 54528 (September
28, 2006), 71 FR 58650 (October 4, 2006) (order approving rules to
govern trading equities).
\395\ See Securities Exchange Act Release No. 55389 (March 2,
2007), 72 FR 10575 (March 8, 2007 (order approving CBOE Stock
Exchange LLC as a facility of CBOE).
\396\ See Securities Exchange Act Release Nos. 57478 (March 12,
2008), 73 FR 14321 (March 18, 2008) (order approving rules governing
the trading of options on the Nasdaq Options Market, LLC); and 61419
(January 26, 2010), 75 FR 5157 (February 1, 2010) (order approving
rules governing the trading of options on BATS Options Exchange,
Inc.).
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The Commission believes that competition among trading venues for
NMS stocks has been facilitated by several Commission rules: Rule 611
(the Order Protection Rule), which encourages quote-based competition
between market centers; Rule 605, which empowers investors and brokers
to compare execution quality statistics across trading venues; and Rule
606, which enables customers to monitor the order routing practices.
Similarly, there is rigorous competition among the options exchanges
that has been facilitated by regulatory efforts. These include the move
to multiple listing,\397\ the extension of the Commission's Quote Rule
to options,\398\ the prohibition against trading outside of the
national best bid and offer,\399\ the adoption of market structures on
the floor-based exchanges that permit individual market maker
quotations to be reflected in the exchange's quotation,\400\ and the
Minimum Quoting Increment Pilot Program.\401\
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\397\ See Securities Exchange Act Release No. 26870 (May 26,
1989), 54 FR 23963 (June 5, 1989) (S7-25-87).
\398\ See Securities Exchange Act Release No. 43591 (November
17, 2000), 65 FR 75439 (December 1, 2000).
\399\ See Securities Exchange Act Release No. 60405 (July 30,
2009), 74 FR 39362 (August 6, 2009) (approved of Options Order
Protection and Locked/Crossed Market Plan).
\400\ See, e.g., Securities Exchange Act Release No. 47959 (May
30, 2003), 68 FR 34441, 34442 (June 9, 2003) (SR-CBOE-2002-05)
(adopting, among other things, amendments to incorporate firm quote
requirements in CBOE's rules).
\401\ On January 26, 2007, the then-existing six options
exchanges implemented a pilot program to quote certain options
series in thirteen classes in one-cent increments (``Minimum Quoting
Increment Pilot Program''). Nasdaq became a participant in the
Minimum Quoting Increment Pilot Program on March 31, 2008, when it
commenced trading on its options platform, and BATS become a
participant in the Pilot Program on February 26, 2010, when it
commenced trading on BATS Options. Since 2007, the Minimum Quoting
Increment Pilot Program has been extended and expanded several
times. See, e.g., Securities Exchange Act Release Nos. 56276 (August
17, 2007), 72 FR 47096 (August 22, 2007) (SR-CBOE-2007-98); 56567
(September 27, 2007), 72 FR 56396 (October 3, 2007) (SR-Amex-2007-
96); 57579 (March 28, 2008), 73 FR 18587 (April 4, 2008) (SR-Nasdaq-
2008-026); 60711 (September 23, 2009), 74 FR 49419 (September 28,
2009) (SR-NYSEArca-2009-44); and 61061 (November 24, 2009), 74 FR
62857 (December 1, 2009) (SR-NYSEArca-2004-44).
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The broker-dealer industry also is a highly competitive industry
with low barriers to entry. Most trading activity is concentrated among
several dozen large participants, with thousands of small participants
competing for niche or regional segments of the market. The reasonably
low barriers to entry for broker-dealers are evidenced, for example, by
the fact that the average number of new broker-dealers entering the
market each year between 2001 and 2008 was 389.\402\
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\402\ This number is based on a Commission staff review of FOCUS
Report filings reflecting registered broker-dealers from 2001
through 2008. The number does not include broker-dealers that are
delinquent on FOCUS Report filings. New registered broker-dealers
for each year during the period from 2001 through 2008 were
identified by comparing the unique registration number of each
broker-dealer filed for the relevant year to the registration
numbers filed for each year between 1995 and the relevant year.
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There are approximately 5,178 registered broker-dealers, of which
approximately 890 are small broker-dealers.\403\ To limit costs and
make business more viable, the small participants often contract with
bigger participants to handle certain functions, such as clearing and
execution, or to update their technology. Larger broker-dealers often
enjoy economies of scale over smaller broker-dealers and compete with
each other to service the smaller broker-dealers, who are both their
competitors and customers.
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\403\ These numbers are based on a review of 2007 and 2008 FOCUS
Report filings reflecting registered broker-dealers, and discussions
with SRO staff. The number does not include broker-dealers that are
delinquent on FOCUS Report filings.
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In the Commission's preliminary judgment, the costs of proposed
Rule 613 would not impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act. In
industries characterized by easy entry and intense competition, the
viability of some of the competitors may be sensitive to regulatory
costs. Nonetheless, the Commission preliminarily believes that the
overall marketplace for NMS securities would remain highly competitive,
despite the costs associated with implementing proposed new Rule 613,
even if those costs influence the entry or exit decisions of some
individual broker-dealer firms.
As discussed above in Sections V and VI, the Commission
acknowledges that the proposal would entail significant costs of
implementation. In particular, requiring national securities exchanges,
national securities associations, and their members to capture the
required information and provide it to the central repository in a
uniform format, in particular information that is not currently
captured under the existing audit trail or other regulatory
requirements, would likely require significant one-time initial
expenses to enhance or modify existing order handling, trading, and
other systems. In addition, national securities exchanges and national
securities associations would need to enhance or create new
surveillance procedures to use the consolidated audit trail
information. Preliminarily, the Commission does not believe that these
implementation expenses would impose an undue burden on competition
among SROs or among other market participants. The Commission
preliminarily believes that the requirements associated with the
proposed Rule are necessary and appropriate, and would apply uniformly
to all national securities exchanges, national securities associations
and their members, and thus would not result in an undue burden on
competition.
As discussed above in Section II, the approach of proposed new Rule
613 would advance the purposes of the Exchange Act in a number of
significant ways. The Commission preliminarily believes that proposed
Rule 613 should aid each of the exchanges and FINRA in carrying out its
statutory obligation to be organized and have the capacity to comply,
and enforce compliance by its members, with its rules, and with the
federal securities laws, rules, and regulations. Likewise, the
Commission believes that proposed Rule 613 should aid the Commission in
fulfilling its statutory obligation to oversee the exchanges and
associations, and to enforce compliance by the members of
[[Page 32604]]
exchanges and associations with the respective exchange's or
association's rules, and the federal securities laws and regulations.
The proposed consolidated audit trail also would aid the Commission in
its efforts to limit the manipulation of security prices, and to limit
the use of manipulative or deceptive devices in the purchase or sale of
a security. By potentially decreasing the opportunities for illegal
activity and market manipulation, the proposed Rule should promote fair
competition among market participants on the basis of effective
regulation. Further, by imposing uniform audit trail requirements on
all SROs and their members, and thus removing any incentive to compete
based on regulation (or lack thereof), the Commission preliminarily
believes that the proposed Rule would allow SROs and their members to
more effectively compete on other terms such as the services provided,
price, and available liquidity.
Based on the analysis above, the Commission preliminarily believes
that the proposal would not impose any burden on competition not
necessary or appropriate in furtherance of the purposes of the Exchange
Act. However, we seek comment on the impact of the proposed Rule on
competition. The Commission requests comment on what, if any, would be
the impact of the proposed Rule on competition among the exchanges and
other non-exchange market centers. If commenters believe there would be
an impact on competition, please explain and quantify the costs or
benefits of such impact. For example, as noted above, exchanges would
have access through the central repository to trading information about
their competitors' customers. Do commenters believe that access to this
information would have an impact on competition among exchanges? If so,
please explain what the potential impact could be, and whether you
believe that such impact would be an adverse. If so, please further
address what, if any, steps the Commission should take in the proposed
Rule to address such concerns.
B. Capital Formation
As discussed above in Section II, proposed Rule 613 is intended to
enhance the ability of the SROs and the Commission to more efficiently
and in a more timely manner monitor trading in NMS securities across
all markets and market participants, which should further the ability
of the SROs and the Commission staff to effectively enforce SRO rules
and federal securities laws, rules and regulations. For example, the
proposed consolidated audit trail would ensure that all orders are
tracked from origination to execution or cancellation. Further, the
consolidated audit trail would provide information on any modifications
or routing decisions made with regard to an order. The Commission
preliminarily believes that the proposed audit trail information would
greatly enhance the ability of its staff to effectively monitor and
surveil the securities markets. This enhanced ability of the SROs and
Commission staff to enforce the federal securities laws, rules, and
regulations should help ensure that market participants that engage in
fraudulent or manipulative activities are identified more swiftly,
which should deter future attempts to do the same. In general, the
faster fraudulent or manipulative activity is identified and action is
taken, the more likely ill-gotten gains will remain available to pay
penalties or compensate victims.
The Commission preliminarily believes that by enhancing the SROs'
and the Commission's ability to enforce the federal securities laws,
rules and regulations, proposed Rule 613 could help maintain or
increase investor confidence in the fairness of the securities markets.
Investor confidence may increase as the potential for the detection of
illegal activity is increased and the risk of investment loss due to
undetected illegal activity decreases. Bolstering investor confidence
in the fairness of the securities markets may increase the level of
investment, which could promote capital formation to the extent that
the increase is allocated efficiently. This would promote capital
formation because as capital is better allocated, issuers with the most
productive capital needs may be better able to raise capital.
C. Efficiency
Proposed Rule 613 would require the creation and maintenance of a
consolidated audit trail, which the Commission preliminarily believes
would greatly enhance the ability of SRO staff to effectively monitor
and surveil the securities markets, and thus detect illegal activity in
a more timely manner, whether on one market or across markets. With an
audit trail designed to help the SROs reconstruct and analyze time-
sequenced order and trading data, the SROs could more quickly
investigate the nature and causes of unusual market movements or
trading activity and initiate investigations and take regulatory
actions where warranted. An increase in detected and prosecuted
violations of the securities laws, rules, and regulations would likely
act as deterrent to future violations. Likewise, the ability of the
Commission to better understand unusual market activity, such as during
a period of intense volatility, could lead to better oversight, or more
focused regulation where warranted, of the causes of such activity. For
example, the possibility of more prompt detection of illegal activity
would likely deter future abusive or manipulative trading activity from
being used to manipulate market prices to artificial levels or by
accelerating a declining market in one or several securities. Thus, the
Commission preliminarily believes that proposed Rule 613 would help to
ensure that markets function efficiently. As a result, the Commission
preliminarily believes that the proposed consolidated audit trail would
help promote the efficient functioning of markets, which should help
enhance the protection of investors and further the public interest.
Further, the Commission preliminarily believes that the proposed
Rule, by creating one central repository to which each national
securities exchange, national securities association, and their members
would be required to provide the same data in the same format, could
reduce or eliminate the need for each individual SRO to have it own
disparate requirements. Elimination of often inconsistent regulation on
members would promote efficiency because members would no longer be
required to submit disparate data to multiple regulators pursuant to
multiple, and sometimes inconsistent, SRO and Commission rules.
The Commission requests comment on all aspects of this analysis
and, in particular, on whether the proposed consolidated audit trail
would place a burden on competition not necessary or appropriate in
furtherance of the purposes of the Exchange Act, as well as the effect
of the proposal on efficiency, competition, and capital formation. The
Commission also requests comment on the impact, if any, of the proposed
Rule on investors' trading activities. Would the proposed Rule impact
investors' incentives to engage in certain types of legal trading in
NMS securities, or other products, on the exchanges or OTC markets that
would be subject to the proposed Rule? If so, why, and what impact
would that have on the competitiveness of the U.S. markets? Would the
proposed Rule impact market participants' incentives to engage in
certain types of illegal trading activity in products other than NMS
securities or in other markets? If so, how so, and what if any steps
should
[[Page 32605]]
the Commission take to address the expected changes in behavior?
Commenters are requested to provide empirical data and other factual
support for their views.
VIII. Consideration of Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996, or ``SBREFA,'' \404\ the Commission must advise the Office
of Management and Budget as to whether the proposed regulation
constitutes a ``major'' rule. Under SBREFA, a rule is considered
``major'' where, if adopted, it results or is likely to result in: (1)
An annual effect on the economy of $100 million or more (either in the
form of an increase or a decrease); (2) a major increase in costs or
prices for consumers or individual industries; or (3) significant
adverse effect on competition, investment or innovation.
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\404\ Pub. L. 104-121, Title II, 110 Stat. 857 (1996) (codified
in various sections of 5 U.S.C., 15 U.S.C. and as a note to 5 U.S.C.
601).
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The Commission requests comment on the potential impact of proposed
Rule 613 on the economy on an annual basis, on the costs or prices for
consumers or individual industries, and on competition, investment or
innovation. Commenters are requested to provide empirical data and
other factual support for their view to the extent possible.
IX. Initial Regulatory Flexibility Act Analysis
The Regulatory Flexibility Act (``RFA'') \405\ requires Federal
agencies, in promulgating rules, to consider the impact of those rules
on small entities. Section 603(a) \406\ of the Administrative Procedure
Act,\407\ as amended by the RFA, generally requires the Commission to
undertake a regulatory flexibility analysis of all proposed rules, or
proposed rule amendments, to determine the impact of such rulemaking on
``small entities.'' \408\
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\405\ 5 U.S.C. 601 et seq.
\406\ 5 U.S.C. 603(a).
\407\ 5 U.S.C. 551 et seq.
\408\ The Commission has adopted definitions for the term small
entity for the purposes of Commission rulemaking in accordance with
the RFA. Those definitions, as relevant to this proposed rulemaking,
are set forth in Rule 0-10, 17 CFR 240.0-10. See Securities Exchange
Act Release No. 18451 (January 28, 1982), 47 FR 5215 (February 4,
1982) (File No. AS-305).
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Proposed Rule 613 of Regulation NMS would require the national
securities exchanges and national securities associations to jointly
develop and file with the Commission a NMS plan to implement and
maintain a consolidated audit trail. Pursuant to such NMS plan, and
rules that would be adopted by the SROs to implement the plan, national
securities exchanges and national securities associations, as well as
their members, would be required to provide data to a central
repository to populate a consolidated audit trail.\409\
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\409\ See proposed Rule 613(c) and supra Sections III.B. and
III.D.
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A. Reasons for the Proposed Rule
The Commission preliminarily believes that with today's electronic,
interconnected markets, there is a heightened need for regulators to
have efficient access to a more robust and effective cross-market order
and execution tracking system. As discussed above, currently many of
the national securities exchanges and FINRA have audit trail rules and
systems to track information relating to orders received and executed,
or otherwise handled, in their respective markets. While the
information gathered from these audit trail systems aids the SRO and
Commission staff in their regulatory responsibility to surveil for
compliance with SRO rules and the federal securities laws and
regulations, the Commission preliminarily believes that existing audit
trails are limited in their scope and effectiveness in varying
ways.\410\ In addition, while the SRO and Commission staff also
currently receives information about orders and/or trades through the
EBS system, Rule 17a-25,\411\ and from equity cleared reports, the
information is limited, to varying degrees, in detail and scope.\412\
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\410\ See supra Section II.A.
\411\ 17 CFR 240.17a-25.
\412\ See supra Sections I.A and I.B. for a description of the
EBS system, Rule 17a-25, and equity cleared reports.
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The creation and implementation of a consolidated audit trail, as
proposed, would enable regulators to better fulfill their regulatory
responsibilities to monitor for and investigate potentially illegal
activity in the NMS for securities in a more timely fashion, whether on
one market or across markets. A consolidated audit trail also would
enhance the ability of the Commission in investigating and preparing
market reconstructions, and in understanding the causes of unusual
market activity. Further, timely pursuit of potential violations can be
important in seeking to freeze and recover any profits received from
illegal activity.
B. Objectives and Legal Basis
Each national securities exchange and national securities
association must be organized and have the capacity to comply, and
enforce compliance by its members, with its rules, and with the federal
securities laws, rules, and regulations.\413\ Likewise, the Commission
oversees the exchanges and associations,\414\ and enforces compliance
by the members of exchanges and associations with the respective
exchange's or association's rules, and the federal securities laws and
regulations.\415\ The Commission preliminarily believes that the
exchanges, FINRA and the Commission itself could more effectively and
efficiently fulfill these statutory obligations to oversee and regulate
the NMS if the SROs and the Commission had direct access to more
robust, and timely, order and execution information across all markets.
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\413\ See, e.g., Sections 6(b)(1), 19(g)(1) and 15A(b)(2) of the
Exchange Act, 15 U.S.C. 78(f)(b)(1), 78s(g)(1), and 78o-3(b)(2).
\414\ See, e.g., Sections 2, 6(b), 15A(b), and 19(h)(1) of the
Exchange Act, 15 U.S.C. 78(b), 15 U.S.C. 78(f)(6), 15 U.S.C. 78o-
3(b), and 15 U.S.C. 78(h)(1).
\415\ See, e.g., 19(h)(1) of the Exchange Act, 15 U.S.C.
78(h)(1).
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The Commission is proposing Rule 613 under the authority set forth
in Exchange Act Sections 2, 3(b), 5, 6, 11, 11A, 15, 15A, 17(a) and
(b), 19, 23(a), and 36 thereof, 15 U.S.C. 78b, 78c(b), 78e, 78f, 78k-1,
78o, 78o-3, 78q(a) and (b), 78s, 78w(a), and 78mm.
C. Small Entities Subject to the Proposed Rule
1. National Securities Exchanges and National Securities Associations
The proposed Rule would apply to national securities exchanges
registered with the Commission under Section 6 of the Exchange Act and
national securities associations registered with the Commission under
Section 15A of the Exchange Act. None of the national securities
exchanges registered under Section 6 of the Exchange Act or national
securities associations registered with the Commission under Section
15A of the Exchange Act that would be subject to the proposed Rule are
``small entities'' for purposes of the RFA.\416\
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\416\ See 17 CFR 240.0-10(e). Paragraph (e) of Rule 0-10 states
that the term ``small business,'' when referring to an exchange,
means any exchange that has been exempted from the reporting
requirements of Rule 601 of Regulation NMS, 17 CFR 242.601, and is
not affiliated with any person (other than a natural person) that is
not a small business or small organization as defined in Rule 0-10.
Under this standard, none of the exchanges subject to the proposed
Rule is a ``small entity'' for the purposes of the RFA. FINRA is not
a small entity as defined by 13 CFR 121.201.
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2. Broker-Dealers
Proposed Rule 613(g) would apply to all broker-dealers that are
members of a national securities exchange or national securities
association. Commission rules
[[Page 32606]]
generally define a broker-dealer as a small entity for purposes of the
Exchange Act and the Regulatory Flexibility Act if the broker-dealer
had a total capital of less than $500,000 on the date in the prior
fiscal year as of which its audited financial statements were prepared,
and it is not affiliated with any person (other than a natural person
that is not a small entity).\417\
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\417\ See 17 CFR 240.0-10(c).
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The Commission estimates that as of December 31, 2008, there were
approximately 890 Commission-registered broker-dealers that would be
considered small entities for purposes of the statute. Each of these
broker-dealers, assuming that they are all members of one or more
national securities exchange or FINRA, would be required to comply with
the proposed Rule.
D. Reporting, Record Keeping, and Other Compliance Requirements
Proposed Rule 613(g)(2) would impose new reporting and record
keeping requirements on small broker-dealers. While certain elements of
order and execution information that such small broker-dealers would be
required to collect and submit to the central repository are already
required to be maintained by broker-dealers pursuant to Rules 17a-3 and
17a-25 under the Exchange Act or the SRO audit trail rules, the
proposed Rule would require the collection of additional information
that is not required to be collected under these rules. Further, small
broker-dealers would be responsible for complying with the proposed
Rule's requirements for reporting to the central repository the
required order and transaction data.
The proposed Rule would require that most of the information
collected be reported on a real time basis, rather than on an ``as
requested'' basis, and that all required information be submitted in a
uniform format. Accordingly, the Commission preliminarily believes that
even those small broker-dealers that already have systems in place for
submitting order and transaction information to regulators upon
request, or to comply with existing SRO audit trail rules, would need
to make modifications to their existing order handling and trading
systems to comply with the proposed Rule, or rely on outside vendors to
provide a functionality that would provide information to the central
repository.
E. Duplicative, Overlapping, or Conflicting Federal Rules
As stated above, broker-dealers are subject to record keeping and
reporting requirements under Rules 17a-3 and 17a-25 under the Exchange
Act. Rule 17a-3 requires that broker-dealers maintain records that
would capture some of the same information required to be collected and
submitted pursuant to the proposed Rule.\418\ Also, as part of the
Commission's existing EBS system, pursuant to Rule 17a-25 under the
Exchange Act, the Commission requires registered broker-dealers to keep
records of some of the information that would be captured by proposed
Rule 613.\419\
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\418\ See 17 CFR 240.17a-3. Pursuant to Rule 17a-3, broker-
dealers are, for example, required to maintain the following
information that would be captured by the proposed rule: Customer
name and address; time an order was received; and price of
execution.
\419\ See 17 CFR 240.17a-25. Pursuant to Rule 17a-25, broker-
dealers are, for example, required to maintain the following
information with respect to customer orders that would be captured
by the proposed Rule, and provide it to the Commission upon request:
Date on which the transaction was executed; account number;
identifying symbol assigned to the security; transaction price; the
number of shares or option contracts traded and whether such
transaction was a purchase, sale, or short sale, and if an option
transaction, whether such was a call or put option; the clearing
house number of such broker or dealer and the clearing house numbers
of the brokers or dealers on the opposite side of the transaction;
prime broker identifier; the customer's name and address; the
customer's tax identification number; and other related account
information.
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However, data collected pursuant to Rules 17a-3 and 17a-25 is
limited in scope and is provided to the Commission only upon request.
The proposed Rule would require the collection of significantly more
information \420\ and would require that most of the information about
orders and executions be provided to the central repository on a real
time basis, not merely be stored and provided upon request. Thus, the
Commission preliminarily believes that while these Federal rules
overlap with certain requirements of the proposed Rule, the scope and
purpose of the proposed Rule is more expansive than what is currently
required and will more efficiently provide regulators with the
information needed to effectively surveil trading activity across
markets.
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\420\ Such additional information would include: A unique
customer identifier for each customer; a unique identifier that
would attach to the order at the time the order is received or
originated by the member and remain with the order through the
process of routing, modification, cancellation, and execution (in
whole or in part); a unique identifier of the broker-dealer
receiving or originating the order; the unique identifier of the
branch office and registered representative receiving or originating
the order; the date on which the order is routed; time at which the
order is routed (in milliseconds); and if the order is executed, in
whole or in part, the account number for any subaccounts to which
the execution is allocated; the unique order identifier of any
contra-side order(s); and the amount of a commission, if any, paid
by the customer, and the unique identifier of the broker-dealer(s)
to whom the commission is paid.
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F. Significant Alternatives
Pursuant to 3(a) of the RFA, the Commission must consider the
following types of alternatives: (1) The establishment of differing
compliance or reporting requirements or timetables that take into
account the resources available to small entities; (2) clarification,
consolidation, or simplification of compliance and reporting
requirements under the Rule for small entities; (3) the use of
performance rather than design standards; and (4) and exemption from
coverage of the proposed Rule, or any part thereof, for small entities.
The Commission has considered whether it would more be more cost
effective to enhance existing systems to achieve the proposed Rule's
objective, rather than create a central repository. For example, the
Commission considered expanding the scope of the information collected
by existing audit trails, the EBS system, and/or Rule 17a-25, but
determined that this approach would not result in the creation of a
comprehensive consolidated audit trail. Under such an approach, SROs
would still need to check multiple repositories of data to gather
information about trading activity occurring across markets. Further,
the goal of capturing data in a uniform format would be complicated if
data were collected by multiple repositories. In addition, this
approach would not resolve concerns over how long it takes to obtain
data when it is not available in real time, but only required to be
provided upon request. Without the centralization of data in a uniform
electronic format, the Commission preliminarily believes that the goals
of the proposed Rule could not be achieved.
The Commission preliminarily believes that proposing a new uniform
audit trail rule that would apply equally across all SROs and their
members would be more efficient and effective than requiring each SRO
to separately amend and enhance its existing order audit trail or EBS
rules and systems, and amending Rule 17a-25. The scope of the proposed
audit trail--requiring each member and SRO to report the same
information for each order, for each reportable event, in a uniform
format, in real time, across all markets--is fundamentally different
than what is collected under existing order audit trails, the EBS
system, and Rule 17a-25.
The Commission also has considered allowing certain small broker-
dealers to submit certain trading data in a manual,
[[Page 32607]]
rather than an electronic, format.\421\ However, the Commission
preliminarily does not believe that the intent and objectives of
proposed Rule 613 could be achieved if small broker-dealers are subject
to differing compliance or reporting requirements, such as manual
reporting of data, or timetables. The Commission preliminarily believes
that to be effective the consolidated audit trail should contain order
and execution information from all broker-dealers, including small
broker-dealers, in a uniform electronic format. Without this
information, the SROs and the Commission would not have a complete and
timely cross-market audit trail to utilize in their regulatory
oversight of small broker-dealers, their customers, and the securities
markets. Further, the Commission preliminarily believes that the
timetable contained in the proposed Rule, which would give brokers-
dealers two years after effectiveness of the NMS plan to implement the
proposed requirements to collect and report the required information to
the central repository, would allow small broker-dealers sufficient
time to modify existing systems, or procure third party functionality,
to comply with the proposed Rule.\422\
---------------------------------------------------------------------------
\421\ See 17a-25 Adopting Release, supra note 20, at 35839-
35840.
\422\ See supra notes 326-330 and accompanying text and notes
356-358 and accompanying text.
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Further, the Commission preliminarily believes that it has drafted
the proposed Rule to be as straightforward as possible to achieve its
objectives. Any simplification, consolidation or clarification of the
Rule should occur for all entities, not just small broker-dealers. The
Commission does not propose to dictate for entities of any size any
particular design standards (e.g., technology) that must be employed to
achieve the objectives of the proposed Rule. However, in order to
provide consistent, comparable data to the central repository, the
nature of the information collected is a design standard.
The Commission would be able to rely on its exemptive authority
under Section 36 of the Exchange Act to grant relief, when necessary,
to small broker-dealers from the requirements of the proposed Rule. The
Commission preliminarily believes that a wholesale exemption from the
proposed Rule for small broker-dealers, however, would make it harder
for the Commission and SROs to recognize the anticipated benefits of
the consolidated audit trail.
G. Solicitation of Comments
The Commission invites commenters to address whether the proposed
Rule would have a significant economic impact on a substantial number
of small entities, and, if so, what would be the nature of any impact
on small entities. The Commission requests that commenters provide
empirical data to support the extent of such impact.
X. Statutory Authority
Pursuant to the Exchange Act and particularly, Sections 2, 3(b), 5,
6, 11A, 15, 15A, 17(a) and (b), 19, and 23(a) thereof, 15 U.S.C. 78b,
78c(b), 78e, 78f, 78k-1, 78o, 78o-3, 78q(a) and (b), 78s and 78w(a),
the Commission proposes Rule 613 of Regulation NMS, as set forth below.
Text of Proposed Rule
List of Subjects in 17 CFR Part 242
Brokers, Reporting and recordkeeping requirements, Securities.
In accordance with the foregoing, Title 17, Chapter II, of the Code
of Federal Regulations is proposed to be amended as follows.
PART 242--REGULATIONS M, SHO, ATS, AC, AND NMS AND CUSTOMER MARGIN
REQUIREMENTS FOR SECURITY FUTURES
1. The authority citation for part 242 continues to read as
follows:
Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2),
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g),
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and
80a-37.
2. Add Sec. 242.613 to read as follows:
Sec. 242.613 Consolidated Audit Trail.
(a) Creation of a National Market System Plan Governing a
Consolidated Audit Trail.
(1) Each national securities exchange and national securities
association shall jointly file on or before [90 days from approval of
this rule] a national market system plan to govern the creation,
implementation, and maintenance of a consolidated audit trail and
central repository as required by this section.
(2) The national market system plan, or any amendment thereto,
filed pursuant to this section shall be filed with the Commission
pursuant to Sec. 242.608.
(3) The national market system plan submitted pursuant to this
section shall require each national securities exchange and national
securities association to:
(i) By two months after effectiveness of the national market system
plan jointly (or under the governance structure described in the plan)
select a person to be the plan processor;
(ii) By four months after effectiveness of the national market
system plan synchronize their business clocks and by four months after
effectiveness of the national market system plan require members of
each such exchange and association to synchronize their business clocks
in accordance with paragraph (d) of this section;
(iii) By one year after effectiveness of the national market system
plan provide to the central repository the data specified in paragraph
(c) of this section;
(iv) By fourteen months after effectiveness of the national market
system plan implement a new or enhanced surveillance system(s) as
required by paragraph (f) of this section; and
(v) By two years after effectiveness of the national market system
plan require members of each such exchange and association to provide
to the central repository the data specified in paragraph (c) of this
section.
(4) Each national securities exchange and national securities
association shall be a sponsor of the national market system plan
submitted pursuant to this section and approved by the Commission.
(5) No national market system plan filed pursuant to this section,
or any amendment thereto, shall become effective unless approved by the
Commission or otherwise permitted in accordance with the procedures set
forth in Sec. 242.608.
(b) Operation and Administration of the National Market System
Plan.
(1) The national market system plan submitted pursuant to this
section shall include a governance structure to ensure fair
representation of the plan sponsors, and administration of the central
repository, including the selection of the plan processor.
(2) The national market system plan submitted pursuant to this
section shall include a provision addressing the requirements for the
admission of new sponsors of the plan and the withdrawal of existing
sponsors from the plan.
(3) The national market system plan submitted pursuant to this
section shall include a provision addressing the percentage of votes
required by the plan sponsors to effectuate amendments to the plan.
(4) The national market system plan submitted pursuant to this
section shall include a provision addressing the manner in which the
costs of operating the central repository will be allocated among the
national securities exchanges
[[Page 32608]]
and national securities associations that are sponsors of the plan,
including a provision addressing the manner in which costs will be
allocated to new sponsors to the plan.
(5) The national market system plan submitted pursuant to this
section shall require the appointment of a Chief Compliance Officer to
regularly review the operation of the central repository to assure its
continued effectiveness in light of market and technological
developments, and make any appropriate recommendations for enhancements
to the nature of the information collected and the manner in which it
is processed.
(c) Data Collection. (1) The national market system plan submitted
pursuant to this section shall provide for an accurate, time-sequenced
record of orders beginning with the receipt or origination of an order
by a member of a national securities exchange or national securities
association, and further documenting the life of the order through the
process of routing, modification, cancellation, and execution (in whole
or in part) of the order.
(2) The national market system plan submitted pursuant to this
section shall require each national securities exchange, national
securities association, and member to collect and provide to the
central repository the information required by paragraph (c)(7) of this
section in a uniform electronic format.
(3) The national market system plan submitted pursuant to this
section shall require each national securities exchange, national
securities association, and member to collect and provide to the
central repository the information required by paragraphs (c)(7)(i)
through (v) of this section on a real time basis.
(4) The national market system plan submitted pursuant to this
section shall require each national securities exchange, national
securities association, and member to collect and provide to the
central repository the information required by paragraphs (c)(7)(vi)
and (vii) of this section promptly after the national securities
exchange, national securities association, or member receives the
information, but in no instance later than midnight of the day that the
reportable event occurred or the national securities exchange, national
securities association, or member receives such information.
(5) The national market system plan submitted pursuant to this
section shall require each national securities exchange and its members
to collect and provide to the central repository the information
required by paragraph (c)(7) of this section for each NMS security
registered or listed for trading on such exchange or admitted to
unlisted trading privileges on such exchange.
(6) The national market system plan submitted pursuant to this
section shall require each national securities association and its
members to collect and provide to the central repository the
information required by paragraph (c)(7) of this section for each NMS
security for which transaction reports are required to be submitted to
the association.
(7) The national market system plan submitted pursuant to this
section shall require each national securities exchange, national
securities association, and any member of such exchange or association
to collect and electronically provide to a central repository details
for each order and each reportable event, including, but not limited
to, the following information:
(i) For the original receipt or origination of the order:
(A) Information of sufficient detail to identify the customer;
(B) A unique customer identifier for each customer;
(C) Customer account information;
(D) A unique identifier that will attach to the order at the time
the order is received or originated by the member and remain with the
order through the process of routing, modification, cancellation, and
execution (in whole or in part);
(E) The unique identifier of the broker-dealer receiving or
originating the order;
(F) The unique identifier of the branch office and registered
representative receiving or originating the order;
(G) Date of order receipt or origination;
(H) Time of order receipt or origination (in milliseconds); and
(I) Material terms of the order.
(ii) For the routing of an order, the following information:
(A) The unique order identifier;
(B) Date on which the order is routed;
(C) Time at which the order is routed (in milliseconds);
(D) The unique identifier of the broker-dealer or national
securities exchange routing the order;
(E) The unique identifier of the broker-dealer or national
securities exchange receiving the order;
(F) If routed internally at the broker-dealer, the identity and
nature of the department or desk to which an order is routed; and
(G) Material terms of the order.
(iii) For the receipt of an order, the following information:
(A) The unique order identifier;
(B) Date on which the order is received;
(C) Time at which the order is received (in milliseconds);
(D) The unique order identifier of the broker-dealer or national
securities exchange receiving the order;
(E) The unique identifier of the broker-dealer or national
securities exchange routing the order; and
(F) Material terms of the order.
(iv) If the order is modified or cancelled, the following
information:
(A) Date the modification or cancellation is received or
originated;
(B) Time the modification or cancellation is received or originated
(in milliseconds);
(C) Price and remaining size of the order, if modified;
(D) Other changes in material terms of the order, if modified; and
(E) Identity of the person giving the modification or cancellation
instruction.
(v) If the order is executed, in whole or in part, the following
information:
(A) The unique order identifier;
(B) Date of execution;
(C) Time of execution (in milliseconds);
(D) Execution capacity (principal, agency, riskless principal);
(E) Execution price and size;
(F) The unique identifier of the national securities exchange or
broker-dealer executing the order; and
(G) Whether the execution was reported pursuant to an effective
transaction reporting plan or the Options Price Reporting Authority
Plan.
(vi) If the order is executed, in whole or in part:
(A) The account number for any subaccounts to which the execution
is allocated (in whole or part);
(B) The unique identifier of the clearing broker or prime broker,
if applicable;
(C) The unique order identifier of any contra-side order(s);
(D) Special settlement terms, if applicable;
(E) Short sale borrow information and identifier; and
(F) The amount of a commission, if any, paid by the customer, and
the unique identifier of the broker-dealer(s) to whom the commission is
paid.
(vii) If the execution is cancelled, a cancelled trade indicator.
(8) All plan sponsors and their members shall use the same unique
customer identifier and unique broker-dealer identifier for each
customer and broker-dealer.
(d) Clock Synchronization. The national market system plan
submitted pursuant to this section shall require
[[Page 32609]]
each national securities exchange, national securities association, and
member of such exchange or association subject to this section to:
(1) Synchronize on its business clocks that are used for the
purposes of recording the date and time of any reportable event that
must be reported pursuant to this section to the time maintained by the
National Institute of Standards and Technology, consistent with
industry standards; and
(2) Evaluate annually the synchronization standard to determine
whether it should be shortened, consistent with changes in industry
standards.
(e) Central Repository.
(1) The national market system plan submitted pursuant to this
section shall provide for the creation and maintenance of a central
repository. Such central repository shall be responsible for the
receipt, consolidation, and retention of all data submitted pursuant to
this section.
(2) Each national securities exchange, national securities
association, and the Commission shall have access to the central
repository, including all systems operated by the central repository,
and access to and use of the data reported to and consolidated by the
central repository under paragraph (c) of this section, for the purpose
of performing its respective regulatory and oversight responsibilities
pursuant to the federal securities laws, rules, and regulations. The
national market system plan submitted pursuant to this section shall
provide that such access to and use of such data by each national
securities exchange, national securities association, and the
Commission for the purpose of performing its regulatory and oversight
responsibilities pursuant to the federal securities laws, rules, and
regulations shall not be limited.
(3) The national market system plan submitted pursuant to this
section shall include a provision requiring the creation and
maintenance by the central repository of a method of access to the
consolidated data that includes search and reporting functions.
(4) The national market system plan submitted pursuant to this
section shall include policies and procedures, including standards, to
be used by the plan processor to:
(i) Ensure the security and confidentiality of all information
submitted to the central repository. All plan sponsors and their
employees, as well as all employees of the central repository, shall
agree to use appropriate safeguards to ensure the confidentiality of
such data and shall agree not to use such data for any purpose other
than surveillance and regulatory purposes. Nothing in this paragraph
(i) shall be construed to prevent a plan sponsor from using the data
that it submits to the central repository for regulatory, surveillance,
commercial, or other purposes as otherwise permitted by applicable law,
rule, or regulation;
(ii) Ensure the timeliness, accuracy, and completeness of the data
provided to the central repository pursuant to paragraph (c) of this
section;
(iii) Require the rejection of data provided to the central
repository pursuant to paragraph (c) of this section that does not meet
these validation parameters and the re-transmission of corrected data;
and
(iv) Ensure the accuracy of the consolidation by the plan processor
of the data provided to the central repository pursuant to paragraph
(c) of this section.
(5) The national market system plan submitted pursuant to this
section shall require the central repository to collect and retain on a
current and continuing basis and in a format compatible with the
information collected pursuant to paragraph (c)(7) of this section;
(i) The national best bid and national best offer for each NMS
security;
(ii) Transaction reports reported pursuant to an effective
transaction reporting plan filed with the Commission pursuant to, and
meeting the requirements of, Sec. 242.601; and
(iii) Last sale reports reported pursuant to the Options Price
Reporting Authority Plan filed with the Commission pursuant to, and
meeting the requirements of, Sec. 242.608.
(6) The national market system plan submitted pursuant to this
section shall require the central repository to retain the information
collected pursuant to paragraphs (c)(7) and (e)(5) of this section in a
convenient and usable standard electronic data format that is directly
available and searchable electronically without any manual intervention
for a period of not less than five years. The information shall be
available immediately, or if immediate availability cannot reasonably
and practically be achieved, any search query must begin operating on
the data not later than one hour after the search query is made.
(f) Surveillance. Every national securities exchange and national
securities association subject to this section shall develop and
implement a surveillance system, or enhance existing surveillance
systems, reasonably designed to make use of the consolidated
information contained in the consolidated audit trail.
(g) Compliance by Members. (1) Each national securities exchange
and national securities association shall file with the Commission
pursuant to section 19(b)(2) of the Act (15 U.S.C. 78s(b)(2)) and Sec.
240.19b-4 on or before [120 days from approval of this rule] a proposed
rule change to require its members to comply with the requirements of
this section and the national market system plan submitted pursuant to
this section and approved by the Commission of which the national
securities exchange or national securities association is a sponsor.
(2) Each member of a national securities exchange or national
securities association that is a sponsor of the national market system
plan submitted pursuant to this section and approved by the Commission
shall collect and submit to the central repository the information
required by paragraph (c) of this section and shall comply with the
synchronization requirements of paragraph (d) of this section.
(3) The national market system plan submitted pursuant to this
section shall include a provision that by subscribing to and submitting
the plan to the Commission, each national securities exchange and
national securities association that is a sponsor to the plan agrees to
enforce compliance by its members with the provisions of the plan.
(4) The national market system plan submitted pursuant to this
section shall include a mechanism to ensure compliance with the
requirements of the plan by the members of a national securities
exchange or national securities association that is a sponsor of the
national market system plan submitted pursuant to this section and
approved by the Commission.
(h) Compliance by National Securities Exchanges and National
Securities Associations. (1) Each national securities exchange and
national securities association shall comply with the provisions of the
national market system plan submitted pursuant to this section and
approved by the Commission of which it is a sponsor.
(2) Any failure by a national securities exchange or national
securities association to comply with the provisions of the national
market system plan submitted pursuant to this section and approved by
the Commission of which it is as sponsor shall be considered a
violation of this section.
(3) The national market system plan submitted pursuant to this
section shall include a mechanism to ensure compliance by the sponsors
of the plan with the requirements of the plan.
[[Page 32610]]
(i) Other Securities and Other Types of Transactions. The national
market system plan submitted pursuant to this section shall include a
provision requiring each national securities exchange and national
securities association to jointly provide to the Commission within two
months after effectiveness of the national market system plan a
document outlining how such exchanges and associations would propose to
incorporate into the consolidated audit trail information with respect
to equity securities that are not NMS securities, debt securities,
primary market transactions in NMS stocks, primary market transactions
in equity securities that are not NMS securities, and primary market
transactions in debt securities, including details for each order and
reportable event that would be required to be provided, which market
participants would be required to provide the data, an implementation
timeline, and a cost estimate.
(j) Definitions.
(1) The term customer shall mean:
(i) The beneficial owner(s) of the account originating the order;
and
(ii) The person exercising investment discretion for the account
originating the order, if different from the beneficial owner(s);
(2) The term customer account information shall include, but not be
limited to, account number, account type, customer type, date account
opened, and large trader identifier (if applicable).
(3) The term material terms of the order shall include, but not be
limited to, the NMS security symbol, security type, price (if
applicable), size (displayed and non-displayed), side (buy/sell), order
type; if a sell order, whether the order is long, short, short exempt;
if a short sale, the locate identifier, open/close indicator, time in
force (if applicable), whether the order is solicited or unsolicited,
whether the account has a prior position in the security; if the order
is for a listed option, option type (put/call), option symbol or root
symbol, underlying symbol, strike price, expiration date, and open/
close, and any special handling instructions.
(4) The term order shall mean:
(i) Any order received by a member of a national securities
exchange or national securities association from any person;
(ii) Any order originated by a member of a national securities
exchange or national securities association; or
(iii) Any bid or offer.
(5) The term reportable event shall include, but not be limited to,
the receipt, origination, modification, cancellation, routing, and
execution (in whole or in part).
Dated: May 26, 2010.
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010-13129 Filed 6-4-10; 8:45 am]
BILLING CODE 8010-01-P