

[Federal Register: November 28, 2005 (Volume 70, Number 227)]
[Notices]               
[Page 71352-71354]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr28no05-103]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52807; File No. SR-NSX-2005-06]

 
Self-Regulatory Organizations; National Stock Exchange; Order 
Approving Proposed Rule Change, and Amendment Nos. 1 and 2 Thereto, To 
Amend the Exchange's Customer Priority Rule To Require Designated 
Dealers To Implement and Maintain Automated Compliance Systems

November 18, 2005.

I. Introduction

    On July 19, 2005, the National Stock ExchangeSM (``NSX'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule

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19b-4 thereunder,\2\ a proposed rule change to amend the text of NSX 
Rule 12.6 (``NSX's Customer Priority Rule'') to require the Exchange's 
Designated Dealers \3\ to implement and maintain automated systems 
reasonably designed to ensure compliance with the NSX Customer Priority 
Rule.\4\ On October 5, 2005, the Exchange filed Amendment No. 1 to the 
proposed rule change. On October 7, 2005, the Exchange filed Amendment 
No. 2 to the proposed rule change. Notice of the proposed rule change, 
as amended, was published for comment in the Federal Register on 
October 18, 2005.\5\ No comments were received regarding the proposal. 
This order approves the proposed rule change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ NSX Rule 5.5(a) defines ``Designated Dealer'' as a 
specialist.
    \4\ The Exchange filed this proposed rule change, in part, 
pursuant to the provisions of the Commission's Order Instituting 
Administrative and Cease-And-Desist Proceedings Pursuant to Sections 
19(b) and 21C of the Securities Exchange Act of 1934, Making 
Findings, and Imposing Sanctions entered May 19, 2005. See In the 
Matter of National Stock Exchange and David Colker, Securities 
Exchange Act Release No. 51715 (May 19, 2005) (``Administrative 
Order''). In Section III.F.6. of the Administrative Order, NSX 
undertook to file proposed rule changes to require its designated 
dealers to implement system enhancements, to the extent practicable, 
such that when a dealer is in the process of executing a proprietary 
trade while in possession of a customer order that could trade in 
place of some or all of the dealer's side of the trade, the 
designated dealer's system will systemically allocate the execution 
to the customer's order unless the trade meets a specified exemption 
in NSX's rules. Pursuant to the undertaking, the proposed rule 
changes must also require that the required system enhancements 
cannot be disabled by NSX's designated dealers.
    \5\ See Securities Exchange Act Release No. 52576 (October 7, 
2005), 70 FR 60594 (``Notice'').
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II. Description of the Proposed Rule Change

    The NSX Customer Priority Rule, currently provides, in part, that 
no member of the Exchange shall: (i) Personally buy or initiate the 
purchase of any security traded on the Exchange for its own account or 
for any account in which it or any associated person of the member is 
directly or indirectly interested while such member holds or has 
knowledge that any person associated with it holds an unexecuted market 
or limit price order to buy such security in the unit of trading for a 
customer, or (ii) sell or initiate the sale of any such security for 
any such account while it personally holds or has knowledge that any 
person associated with it holds an unexecuted market or limit price 
order to sell such security in the unit of trading for a customer.\6\
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    \6\ See NSX Rule 12.6(a).
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    NSX proposes to amend the text of the NSX Customer Priority Rule to 
require the Exchange's Designated Dealers to implement and maintain 
automated systems reasonably designed to ensure compliance with the NSX 
Customer Priority Rule.\7\ The proposed rule change would also prohibit 
Designated Dealers from disabling or disengaging their automated 
systems, except under limited circumstances.\8\ Furthermore, the 
proposed rule would make clear that, if a Designated Dealer holds for 
execution on the Exchange a customer buy order and a customer sell 
order that can be crossed, the Designated Dealer's automated system 
shall systemically cross them.\9\
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    \7\ See Proposed NSX Rule 12.6(e).
    \8\ Id.
    \9\ See Proposed Interpretations and Policies .01 to NSX Rule 
12.6.
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    NSX also proposes to provide that, for purposes of Rule 12.6, a 
member or any associated person of a member responsible for entering 
orders for its own account or any account in which it is directly or 
indirectly interested shall be presumed to have knowledge of a 
particular customer order.\10\ The proposed interpretation would also 
provide that such presumption can be rebutted by adequate evidence that 
effectively demonstrates, to the Exchange's satisfaction, that the 
member has implemented a reasonable system of internal policies and 
procedures and has as adequate system of internal controls to prevent 
the misuse of information about customer orders by those responsible 
for entering such proprietary orders.\11\
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    \10\ See Proposed Interpretations and Policies .03 to NSX Rule 
12.6.
    \11\ Id.
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III. Discussion and Commission Findings

    The Commission has reviewed the proposed rule change, as amended, 
and finds that it is consistent with the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\12\ Specifically, the Commission finds that the proposed rule 
change, as amended, furthers the objectives of Section 6(b)(1) \13\ of 
the Act, which requires the Exchange to be so organized and have the 
capacity to be able to carry out the purposes of the Act and to comply, 
and to enforce compliance by its members, with the Act and the rules of 
the Exchange. In addition, the Commission finds that the proposed rule 
change, as amended, is consistent with Section 6(b)(5) of the Act,\14\ 
which requires, among other things, that the rules of a national 
securities exchange be designed to promote just and equitable 
principles of trade, to remove impediments to and perfect the mechanism 
of a free and open market and a national market system, and, in 
general, to protect investors and the public interest.
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    \12\ In approving this proposed rule change, the Commission 
notes that it has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
    \13\ 15 U.S.C. 78f(b)(1).
    \14\ 15 U.S.C. 78f(b)(5).
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    Currently, NSX Rule 12.6 prohibits an NSX member from trading ahead 
of its customers' orders. Customer order protection ensures that 
members consider the orders of their customers when executing their own 
orders and thus prevents the isolation of customer orders that might 
otherwise occur if a member were freely able to trade ahead of its 
customers' orders. The Commission believes that the proposed rule 
change should enhance investor confidence by helping to improve the 
quality of executions for customers. By ensuring a customer order's 
priority over the member's proprietary trading, more trade volume 
should be available to be matched with the customer's order, resulting 
in quicker and more frequent executions for customers. Specifically, 
the Commission believes that proposed NSX Rule 12.6(e) and 
Interpretations and Policies .01 to NSX Rule 12.6 should enhance the 
customer protections already provided by NSX Rule 12.6 by requiring NSX 
specialists to implement and maintain automated systems reasonably 
designed to ensure compliance with NSX Rule 12.6 and requiring that if 
an NSX specialist is able to cross two customer orders, such 
specialist's automated system shall systemically cross such order 
without the specialist interposing itself as a dealer.
    Proposed Interpretations and Policies .03 to NSX Rule 12.6 would 
define what constitutes knowledge for purposes of NSX Rule 12.6 to 
provide that a member or any associated person of a member responsible 
for entering orders for its own account or any account in which it is 
directly or indirectly interested shall be presumed to have knowledge 
of a particular unexecuted customer order and would provide that such 
knowledge can be rebutted by adequate evidence that the member has 
implemented a reasonable system of internal policies and procedures and 
has an adequate system of internal controls to prevent misuse of 
information about customer orders by those responsible for entering 
such proprietary orders. The Commission believes that the proposed 
interpretation is substantially similar to a rule of the New York Stock 
Exchange, Inc. interpreting its trading ahead

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rules,\15\ and that such proposed interpretation raises no new issues 
or regulatory concerns.
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    \15\ See Securities Exchange Act Release No. 44139 (March 30, 
2001), 66 FR 18339 (April 6, 2001) (approving proposed rule change 
SR-NYSE-94-34, including Supplementary Material .10 of NYSE Rule 
92).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the proposed rule change (File No. SR-NSX-2005-06) and 
Amendment Nos. 1 and 2, thereto be, and hereby are, approved.
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    \16\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
 [FR Doc. E5-6562 Filed 11-25-05; 8:45 am]

BILLING CODE 8010-01-P
