SEC Approves Changes to Rules on Reporting of Transactions through Electronic Communications Networks (ECNs)

ACTION REQUIRED

Electronic Communications Networks

Changes Effective: November 10, 2003

Executive Summary

NASD is issuing this Notice to replace and supersede Notice to Members (NtM) 03-55, which discussed the SEC's approval of rules on reporting of transactions executed through electronic communications networks (ECNs). The effective date of the rules was originally October 6, 2003, but was delayed until November 10, 2003. Minor amendments to the rules have since been filed with the Securities and Exchange Commission (SEC) on an immediately effective basis, and are reflected in this Notice. This Notice also repeats information that is in NtM 03-55.

On September 4, 2003, the SEC approved changes to rules governing the reporting of transactions through Nasdaq's Automated Confirmation Transaction Service (ACT) in order to clarify the reporting requirements applicable to transactions conducted through electronic communications networks (ECNs).

The new rules do not apply to trades reported through NASD's Trade Reporting and Comparison Service (TRACS). The changes, which take effect November 10, 2003, describe the three methods that may be used by ECNs and/or their customers to report trades executed through an ECN's facilities. ECNs that use ACT to report some or all of the transactions executed through their facilities are required to file a notice of their trade-reporting methods prior to November 10, 2003. Please use Attachment A to file this notice. Notices must be filed with NASDAQ's MarketWatch Department, 9509 Key West Avenue, Rockville, MD 20850, Attention: Sheila Dagucon (or you may fax the notification to (240) 386-6050); and NASD's Market Regulation Department, 9509 Key West Avenue, Rockville, MD 20850, Attention: Alternative Trading Systems Group (or you may fax the notification to (240) 386-5139).

Questions/Further Information

Questions regarding this Notice may be directed to Sheila Dagucon, NASDAQ MarketWatch, at (240) 386-6049; or John Yetter, NASDAQ Office of General Counsel, at (202) 912-3039.

Background

Current practices of ECN trade reporting have developed over time in conjunction with the growth of the number of ECNs. As each new ECN entered the market, it registered under NASD Rule 4623 and informed NASDAQ and NASD concerning its planned method for reporting transactions. Although the use of different reporting methodologies by different ECNs has generally allowed ECNs to fulfill reporting obligations while tailoring their methodology to their own business needs and those of their subscribers, the absence of clearly defined rules has, in some circumstances, created confusion as to the trade reporting responsibilities of ECNs and their subscribers. The rule change approved by the Commission will provide members greater certainty concerning their trade reporting responsibilities, while allowing ECNs to continue using the various methods of trade reporting that have developed over time.

The rule change is based on NASDAQ's understanding of the different methods used by ECNs today to report trades, and, in general, the rule change is not intended to require ECNs to modify their current trade-reporting practices. Rather, the purpose of the rule change is to codify these practices in the form of clear, enforceable rules that will provide greater guidance to market participants. The rule change will apply to transactions in all securities that are executed through an ECN and reported to ACT.

The rule change permits ECNs to use any of three methods for reporting transactions. However, each ECN must inform, in writing, NASD and NASDAQ simultaneously which method it will use for reporting trades to ACT for each of its subscribers, although it may change its method at any time by providing advance written notice simultaneously to NASD and NASDAQ.

First, an ECN may assume sole responsibility for reporting transactions executed through its facilities and identify itself as the reporting party.

Second, an ECN may assume sole responsibility for transaction reporting, but identify a subscriber as the reporting party. In that case, the identified reporting party would be determined in accordance with the existing rules for allocating trade-reporting responsibility in NASD Rule 6130(c). Thus, if the subscribers conducting a transaction through the ECN were both market makers or both Order Entry Firms, the selling party would be identified as the reporting party; if the transaction were between a market maker and an Order Entry Firm, the market maker would be identified as the reporting party; and if the transaction were between a member (i.e., a broker/dealer) and a non-member (such as an institutional investor), the member would be identified as the reporting party.

Third, the ECN may impose some or all of the responsibility for reporting on its subscribers. In that case, the ECN would notify the appropriate reporting party, determined in accordance with the existing rules of priority for trade reporting in NASD Rule 6130(c), that it had an obligation to submit a report concerning the trade.

At any given time, an ECN may utilize more than one of these methods, with the choice of the method varying depending on the needs of particular subscribers. Thus, an ECN may use one method for one of its subscribers and a different method for all of its other subscribers. The ECN must, however, provide simultaneously NASD and NASDAQ advance written notice concerning the method that it will use for each subscriber.

In each case, the party submitting a trade report is responsible for ensuring its accuracy and completeness, by providing the information specified by Rule 6130(d). In addition, when an ECN submits a trade report identifying another party as the reporting party, both the ECN and the identified reporting party are responsible for ensuring the accuracy and completeness of the report.

The rule change also addresses procedures for reporting transactions in several unique circumstances associated with ECNs. First, the rule change provides that when the parties to a transaction executed through an ECN are both non-members, the ECN must submit all required trade reports and identify itself as the reporting party. This is the case because, as non-members, the parties to the transaction would not be eligible to report trades through ACT. Second, in circumstances where one ECN routes an order to another ECN that executes the order, the ECN that executes the order would be responsible for reporting the transaction, or requiring a subscriber to report the transaction, in accordance with one of the three basic methods for trade reporting described above. For purposes of the rules for allocating trade-reporting responsibility between ECN subscribers, the routing ECN would be deemed to be an Order Entry Firm. Thus, if the executing ECN uses the second method of trade reporting (i.e., reporting on behalf of its subscribers), and it receives an order from a routing ECN that is matched against the order of an Order Entry Firm or another ECN, the sell side would be identified as the reporting party. If the executing ECN matched the routed order against the order of a market maker, however, the market maker would be identified as the reporting party.

Finally, it should be noted that the rule change applies only to transactions that are reported to ACT, since NASDAQ does not have authority to establish rules governing the reporting of trades to non-NASDAQ systems, including NASD's TRACS system. Thus, in circumstances where an ECN has the option to report trades to ACT or to another trade-reporting system, such as NASD's TRACS system, the rule does not mandate that the ECN use ACT for trade reporting. However, to the extent that the ECN or its subscribers opt to use ACT to report a particular transaction, all provisions of the rule change would apply to that transaction.

Attachment A

Notice Required by NASD Rule 6130(c) for Electronic Communications Network (ECN) Transactions Reported through the Automated Confirmation Transaction Service (ACT)

Trade-reporting methods:

Notice should be sent to:

• NASDAQ's MarketWatch Department
  9509 Key West Avenue
  Rockville, MD 20850



 
• Or you may fax the notification to (240) 386-6050
  
  Attention: Sheila Dagucon
  
  AND



 
• NASD's Market Regulation Department
  9509 Key West Avenue
  Rockville, MD 20850



 
• Or you may fax the notification to (240) 386-5139
  
  Attention: Alternative Trading Systems Group

Attachment B

TEXT OF AMENDMENTS

New text is underlined; deletions are in brackets.

5400. NASDAQ STOCK MARKET AND ALTERNATIVE DISPLAY FACILITY TRADE REPORTING

5430. Transaction Reporting

6100. AUTOMATED CONFIRMATION TRANSACTION SERVICE (ACT)

6110. Definitions

6130. Trade Report Input

6400. REPORTING TRANSACTIONS IN LISTED SECURITIES

6420. Transaction Reporting

IM-6420. Transactions in Eligible Securities

Summary Of Provisions Governing Members' Requirements To Report Transaction In Eligible Securities

Chart 1 — General Reporting Requirements Under Rule 6420(b)

Chart II — Reporting Requirements for "Riskless" Transactions as Defined in Rule 6420(d)(4)

6600. REPORTING TRANSACTIONS IN OVER-THE-COUNTER SECURITIES

6620. Transaction Reporting

6900. REPORTING TRANSACTIONS IN DIRECT PARTICIPATION PROGRAMS

6920. Transaction Reporting.