

[Federal Register: October 31, 2006 (Volume 71, Number 210)]
[Notices]               
[Page 63812-63814]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr31oc06-97]                         


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54650; File No. SR-NASD-2004-130]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Notice of Filing of Proposed Rule Change and Amendment 
Nos. 1 and 2 Relating to Amendments to Rule 2320(g) (Three Quote Rule) 
and Corresponding Recordkeeping Requirements Under Rule 3110(b)

 October 25, 2006.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on August 27, 2004, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by NASD. On 
May 8, 2006, NASD filed Amendment No. 1 to the proposed rule change.\3\ 
On October 19, 2006, NASD filed Amendment No. 2 to the proposed rule 
change.\4\ The Commission is publishing this notice to solicit comments 
on the proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaced and superceded in its entirety the 
text of the original filing.
    \4\ Amendment No. 2 replaced and superceded in its entirety the 
text of the original filing, as amended.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD is proposing to amend Rule 2320(g) (``Three Quote Rule'') and 
the corresponding recordkeeping requirements under Rule 3110(b) to 
exclude from the Three Quote Rule's coverage transactions in foreign 
securities of a foreign issuer that are part of the FTSE All-World 
Index.
    Below is the text of the proposed rule change. Proposed new 
language is in italics; proposed deletions are in brackets.
* * * * *

2320. Best Execution and Interpositioning

    (a) through (f) No Change.
    (g) (1) Except as provided in subparagraph (3) below, [Unless two 
or more priced quotations for a non-exchange-listed security (as 
defined in the Rule 6600 Series) are displayed in an inter-dealer 
quotation system that permits quotation updates on a real-time basis,] 
in any transaction for or with a customer pertaining to the execution 
of an order in a non-exchange-listed security (as defined in the Rule 
6600 Series), a member or person associated with a member shall contact 
and obtain quotations from three dealers (or all dealers if three or 
less) to determine the best inter-dealer market for the subject 
security.
    (2) No Change.
    (3) The requirements described in subparagraph (1) above shall not 
apply:
    (A) when two or more priced quotations for a non-exchange-listed 
security are displayed in an inter-dealer quotation system that permits 
quotation updates on a real-time basis; or
    (B) to any transaction pertaining to the execution of an order in a 
non-exchange-listed security of a foreign issuer that is part of the 
FTSE All-World Index if such transaction is executed during the regular 
business hours of the foreign market for the foreign security and no 
trading halt or other similar trading or quoting restriction is in 
effect in any foreign market on which such foreign security is listed.
    (4) Definitions.
    For purposes of this paragraph (g): [,]
    (A) T[t]he term ``inter-dealer quotation system'' means any system 
of general circulation to brokers or dealers that regularly 
disseminates quotations of identified brokers or dealers.
    (B) [(4) For purposes of this paragraph,] T[t]he term ``quotation 
medium'' means any inter-dealer quotation system or any publication or 
electronic communications network or other device that is used by 
brokers or dealers to make known to others their interest in 
transactions in any security, including offers to buy or sell at a 
stated price or otherwise, or invitations of offers to buy or sell.
    (5) No Change.
* * * * *

3110. Books and Records

    (a) No Change.
    (b) Marking of Customer Order Tickets
    A person associated with a member shall indicate on the memorandum 
for each transaction in a non-exchange-listed security, as that term is 
defined in the Rule 6600 Series, the name of each dealer contacted and 
the quotations received to determine the best inter-dealer market; 
however, the requirements of this subparagraph shall not apply if the 
member can establish and has documented that:
    (1) two or more priced quotations for the security are displayed in 
an inter-dealer quotation system, as defined in Rule 2320(g), that 
permits quotation updates on a real-time basis for which NASD 
[Regulation] has access to historical quotation information; or
    (2) the transaction is effected in compliance with Rule 
2320(g)(3)(B).
    (c) through (j) No Change.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. NASD has prepared summaries, set forth in Sections A, B, 
and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
Rule Filing History
    On August 27, 2004, NASD filed with the Commission proposed rule 
change SR-NASD-2004-130, proposing amendments to Rule 2320(g) and Rule 
3110(b) to exclude from the Three Quote Rule's coverage transactions in 
foreign securities of a foreign issuer that are part of the FTSE World 
Index. On May 8, 2006, NASD filed Amendment No. 1 to change the 
proposed exclusion from the Three Quote Rule's coverage transactions in 
foreign securities of a foreign issuer that are part of the FTSE All-
World Index, rather than the FTSE World Index.\5\
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    \5\ The FTSE World Index is a sub-set of the FTSE All-World 
Index. The list of securities that comprise the FTSE All-World Index 
are substantially similar to the list of securities that comprise 
the FTSE World Index. The key difference is that the FTSE All-World 
Index is comprised of securities from Developed, Advanced Emerging 
and Secondary Emerging markets, whereas the FTSE World Index is 
comprised of securities from Developed and Advanced Emerging market 
segments only. The FTSE World Index, however, is no longer offered 
other than to existing FTSE subscribers. Given that the FTSE World 
Index would not be widely accessible, NASD amended its filing 
accordingly. See Exhibit 2 to Amendment No. 2 for additional 
details, available on the NASD's Web site at http://www.nasd.com.

    The information in this proposed rule change, as amended, and in 
Exhibit 2 thereto relating to the FTSE All-World Index is based on 
information published on FTSE's Web site at http://www.ftse.com, as well as 

from conversations between NASD staff and FTSE staff.
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    On June 30, 2006, the Commission approved SR-NASD-2005-087, which

[[Page 63813]]

amended certain NASD rules to reflect the separation of Nasdaq from 
NASD upon the operation of the Nasdaq Exchange as a national securities 
exchange.\6\ Among other amendments, SR-NASD-2005-087 amended Rules 
2320(g) and 3110(b) to replace the term ``non-Nasdaq securities'' with 
``non-exchange-listed securities.'' SR-NASD-2005-087 became effective 
on August 1, 2006, the date upon which Nasdaq began operation as an 
exchange for Nasdaq-listed securities.
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    \6\ See Securities Exchange Act Release No. 54084 (June 30, 
2006), 71 FR 38935 (July 10, 2006).
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    Given the Commission's approval of SR-NASD-2005-087, NASD filed 
Amendment No. 2. Amendment No. 2, which replaces and supersedes the 
prior filings in their entirety, amends the proposed rule text and 
description to reflect Nasdaq's operation as an exchange, among other 
clarifying changes.
Proposal
    The Three Quote Rule originally was adopted on May 2, 1988,\7\ as 
an amendment to NASD's best execution interpretation and generally 
requires that members that execute transactions in non-exchange-listed 
securities \8\ on behalf of customers contact a minimum of three 
dealers (or all dealers if three or less) and obtain quotations, if 
there are fewer than two quotations displayed on an inter-dealer 
quotation system that permits quotation updates on a real-time basis. 
The Three Quote Rule further defined a member's best execution 
obligation to customers by setting forth additional requirements for 
transactions in non-exchange-listed securities, particularly 
transactions involving relatively illiquid securities with non-
transparent prices. The Three Quote Rule is a minimum standard, and 
compliance with the rule, in and of itself, does not mean a member has 
met its best execution obligations.
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    \7\ See Securities Exchange Act Release No. 25637 (May 2, 1988), 
53 FR 16488 (May 9, 1988).
    \8\ The Three Quote Rule applies to transactions in all non-
exchange-listed securities. A non-exchange-listed security is 
defined in NASD Rule 6610 as ``any equity security that is not 
traded on any national securities exchange * * *.'' Therefore, the 
rule by its terms applies to transactions effected on any foreign 
exchange. The term ``national securities exchange'' is not defined 
in NASD rules, but the requirements to qualify are set forth in 
Sections 6(a) and 19(a) of the Act. See 15 U.S.C. 78f(a) and 78s(a). 
See also Securities Exchange Act Release No. 39266 (October 22, 
1997), 62 FR 56217 (October 29, 1997).
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    Since the adoption of the Three Quote Rule, the market for non-
exchange-listed securities has changed significantly. NASD has found 
that under certain circumstances, the Three Quote Rule often can 
hinder, rather than further, best execution by causing significant 
delays in obtaining executions of customer orders. For example, in 
2000, NASD amended the Three Quote Rule to eliminate the requirement to 
contact three market makers when there are at least two priced 
quotations displayed in an inter-dealer quotation system that permits 
quotation updates on a real-time basis.\9\ NASD concluded that, where 
there were two transparent, firm quotes, the costs associated with 
delayed executions resulting from compliance with the Three Quote Rule 
were not outweighed by the benefits of obtaining three telephone 
quotes.
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    \9\ See Securities Exchange Act Release No. 43319 (September 21, 
2000), 65 FR 58589 (September 29, 2000). This rule change also 
alleviated the corresponding recordkeeping requirements under Rule 
3110(b) where NASD could validate and confirm compliance with 
applicable requirements directly through its internal historical 
data.
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    Similar concerns have been raised with respect to the Three Quote 
Rule's application in the area of orders in foreign securities of 
foreign issuers. Certain members and other interested parties had 
raised concerns that the Three Quote Rule was unnecessary and 
potentially harmful to the customer's best interests when a member, 
using reasonable diligence, has determined that the best market for a 
foreign security is a foreign market where the securities trade with 
sufficient liquidity and transparency.
    NASD staff agreed that the protections of the Three Quote Rule may 
not be necessary with respect to all orders in foreign securities. In 
fact, according to the NASD, the Commission, in its approval order 
granting NASD exemptive authority with respect to the Three Quote Rule, 
specifically indicated that exemptive relief may be appropriate for 
transactions executed on a foreign exchange.\10\ The NASD noted that 
the Commission stated that exemptive relief may be appropriate in such 
circumstances because the foreign exchange may constitute the best 
market for securities that are listed on that market and the time delay 
involved in contacting three dealers may, therefore, hinder a member 
from obtaining best execution for the customers.\11\
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    \10\ See Securities Exchange Act Release No. 39266 (October 22, 
1997), 62 FR 5617 (October 29, 1997).
    \11\ Id.
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    Accordingly, NASD is proposing amendments that would exclude from 
the Three Quote Rule's coverage transactions effected in foreign 
securities of foreign issuers that are part of the FTSE All-World 
Index.\12\ Therefore, under the proposed rule change, a member would 
not be required to obtain three quotes in connection with transactions 
in foreign securities that are part of the FTSE All-World Index. The 
proposed rule change would not require that the transaction be executed 
on a foreign market so as not to limit the member's ability to 
determine, in fulfilling its best execution obligations, that a better 
execution would be obtained off the foreign market. However, to qualify 
for the exemption, the transaction must be executed during regular 
business hours of the foreign market for the security and no trading 
halt or other similar trading or quotation restriction may be in effect 
in any foreign market on which for such foreign security is listed.\13\
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    \12\ NASD states that the Financial Times and the London Stock 
Exchange operate the FTSE All-World Index. The FTSE All-World Index 
includes 48 different countries and approximately 3,000 stocks. See 
Exhibit 2 to Amendment No. 2 for a detailed description of the 
criteria used to determine the FTSE All-World Index.
    \13\ Contingent upon approval of the proposed rule change, NASD 
staff plans to withdraw all existing exemptions it has granted to 
the Three Quote Rule that relate to foreign securities. NASD staff 
has granted seven exemptions for customer transactions in Canadian 
securities executed on a Canadian exchange on an agency or riskless 
principal basis. See, e.g., Letter to Mr. Kenneth W. Perlman, 
General Counsel, Mayer & Schweitzer, Inc., from Alden S. Adkins, 
Senior Vice President and General Counsel, NASD Regulation, Inc., on 
May 29, 1998.
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    NASD has selected the FTSE All-World Index in part because, 
according to the NASD, Commission staff has deemed the foreign 
securities that are listed on the FTSE World Index, a subset of the 
FTSE All-World Index, as having a ``ready market'' and therefore 
eligible to receive comparable favorable treatment to U.S. equity 
securities under the securities haircut \14\ provisions of the SEC's 
net capital rule.\15\ In addition, the Federal Reserve Board recognizes 
the FTSE World Index for determining whether stocks are eligible for 
margin treatment. NASD believes that the criteria used in determining 
the composition of the FTSE World Index, which are substantially the 
same for the FTSE All-World Index, helps to ensure that the securities 
trade with a high

[[Page 63814]]

degree of liquidity, consistency, and price transparency.\16\
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    \14\ NASD notes that the Commission's net capital rule requires 
broker-dealers, when computing net capital, to deduct from their net 
worth certain percentages of the market value of their proprietary 
securities positions, commonly referred to as ``haircuts.'' Haircuts 
are calculated under paragraphs (c)(2)(vi), (c)(2)(vii), and 
applicable appendices of the standard net capital rule, SEC Rule 
15c3-1. 17 CFR 240.15c3-1.
    \15\ See 1993 SEC No-Act LEXIS 967 (August 13, 1993) (regarding 
foreign equity issues listed on the FT-Actuaries World Index as 
having a ready market with respect to the ready market and haircut 
provisions of the SEC's net capital rule). NASD states that the 
calculation of the FT/S&P Actuaries World Index was taken over by 
FTSE in November 1999 and renamed the FTSE World Index, which is a 
subset of the FTSE All-World Index.
    \16\ The FTSE All-World Index is based on a set of rules that 
govern the construction and maintenance of the index. Stocks 
comprising the FTSE All-World Index are screened to, among other 
things, ensure there is sufficient liquidity and the availability of 
accurate and timely data. Factors in determining liquidity include 
the level of trading volume relative to shares outstanding. See 
Exhibit 2 to Amendment No. 2 for further information.
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    Importantly, while the proposed rule change would not require a 
member to obtain three quotes in connection with transactions in 
foreign securities that are part of the FTSE All-World Index, members 
would continue to be required to comply with their best execution 
obligations under Rule 2320, and to the extent applicable, their 
suitability obligations under Rule 2310.
    The proposed rule change also would provide a corresponding 
exclusion to the recordkeeping requirements set forth in Rule 3110(b) 
relating to the Three Quote Rule if the member can establish and 
document its reliance on this exclusion. Rule 3110(b) requires that 
members indicate on the order ticket for each transaction in a non-
exchange-listed security the name of each dealer contacted and the 
quotations received to determine the best inter-dealer market as 
required by the Three Quote Rule.
    In addition, NASD no longer refers to its subsidiary, NASD 
Regulation, Inc., using its full corporate name, ``NASD Regulation'' or 
``NASD Regulation, Inc.'' Instead, NASD uses ``NASD'' unless otherwise 
appropriate for corporate or regulatory reasons. Accordingly, the 
proposed rule change replaces one reference to ``NASD Regulation'' in 
the text of the proposed rule change with ``NASD.''
    Finally, NASD will announce the effective date of the proposed rule 
change in a Notice to Members to be published no later than 60 days 
following Commission approval. The effective date will be 30 days 
following publication of the Notice to Members announcing Commission 
approval.
2. Statutory Basis
    NASD believes that the proposed rule change, as amended, is 
consistent with the provisions of Section 15A of the Act \17\ in 
general, and with Section 15A(b)(6) of the Act \18\ in particular, in 
that it is designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, and, in 
general, to protect investors and the public interest. NASD believes 
that the proposed rule change will reduce the time and effort necessary 
in contacting three dealers in orders for foreign securities of certain 
foreign issuers where it has been demonstrated that such securities are 
trading with sufficient liquidity and price transparency.
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    \17\ 15 U.S.C. 78o-3.
    \18\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number SR-NASD-2004-130 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.
    All submissions should refer to File Number SR-NASD-2004-130. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). Copies of the submission, all subsequent amendments, 

all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Room. Copies of such 
filing also will be available for inspection and copying at the 
principal office of NASD. All comments received will be posted without 
change; the Commission does not edit personal identifying information 
from submissions. You should submit only information that you wish to 
make available publicly. All submissions should refer to File Number 
SR-NASD-2004-130 and should be submitted on or before November 21, 
2006.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
 [FR Doc. E6-18250 Filed 10-30-06; 8:45 am]

BILLING CODE 8011-01-P
