Notice To Members 88-40

Adoption of New Schedule H to the NASD By-Laws and Proposed Amendment to Article III, Section 21 of the NASD Rules of Fair Practice.

Published Date:

June 01, 1988

IMPORTANT MAIL VOTE

OFFICERS, PARTNERS, PROPRIETORS

TO: All NASD Members

LAST VOTING DATE IS JULY 1, 1988.

EXECUTIVE SUMMARY

NASD members are invited to vote on a proposed amendment to Article III, Section 21 of the NASD Rules of Fair Practice. The amendment would require the marking of customer order tickets to reflect the dealers contacted by members and the quotations received to determine the best inter-dealer market as required by an amendment to the NASD's "Best Execution Interpretation" which has been approved by the Securities and Exchange Commission (SEC).

In a separate but related matter, the SEC approved the NASD's adoption of new Schedule H to the NASD By-Laws, which establishes an electronic system of mandatory price and volume reporting for over-the-counter securities that are not part of the National Association of Securities Dealers Automated Quotations (NASDAQ) System.

The text of the proposed amendment to Article III, Section 21 is attached.

BACKGROUND

In letters to the NASD, dated October 8, 1985, and June 17, 1987, the SEC directed the NASD, to develop a nationwide automated market surveillance program for non-NASDAQ, over-the-counter (OTC) securities (commonly referred to as "pink sheet" stocks) and to develop a rule requiring member firms making a market in these securities to periodically report price and volume information to the NASD.

In response to the SEC's concerns, the NASD adopted proposed rule changes that provide for the routine surveillance of the non-NASDAQ, OTC securities market. The proposed rule changes, providing for a new Schedule H to the NASD By-La ws, were approved by the SEC on May 2, 1988.^1/ New Schedule H defines the terms "non-NASDAQ security" and "non-NASDAQ reporting system" and establishes minimum threshold reporting requirements for non-NASDAQ, OTC securities.

EXPLANATION OF AMENDMENTS

Schedule H to the NASD By-Laws

Section 1 of new Schedule H defines the term "non-NASDAQ reporting system" to encompass any electronic price and volume reporting system operated by the NASD for non-NASDAQ securities. The term "non-NASDAQ security" is defined as any equity security that is neither included in the NASDAQ System nor traded on any national securities exchange. ^2/

Section 2 of Schedule H requires members executing principal transactions in non-NASDAQ securities to provide price and volume data for both purchase and sale transactions if the member's aggregate daily volume of either sales or purchases exceeds either a minimum of 50,000 shares or $10,000. For example, if a member executes an aggregate purchase volume of 70,000 shares and has an aggregate sale volume of 20,000 shares, it will be required to report aggregate volume for both the purchases and sales, as well as price data, because the minimum threshold level was reached on the buy side of the market.

The provisions of Section 2(a) of Schedule H also require members to report the highest price at which the member sold the non-NASDAQ security meeting the minimum reporting level and the lowest price at which the member purchased the security. The price to be reported on customer transactions would be inclusive of mark-ups or mark-downs. In addition, the member would be required to indicate whether the trades that established these high and low prices represented an execution with a customer or with another broker-dealer.

Section 2(b) of Schedule H provides for daily reporting of price and volume information of principal transactions on non-NASDAQ securities executed by members. Members will have the option to report price and volume information either between the hours of 4 p.m. and 6:30 p.m. Eastern Time on the trade date or between 7:30 a.m. and 9 a.m. Eastern Time on the next business day.

The new rules also amend the Interpretation of the Board of Governors-Execution of Retail Transactions in the Over-the-Counter Market (the "Best Execution Interpretation") by adding a new paragraph (D) that requires members to check a minimum of three dealers (or all dealers in a security if three or less) prior to executing any transaction on behalf of a customer in a non-NASDAQ security.

Article m, Section 21 to the Rules of Fair Practice

In order for members to demonstrate compliance with the new amendment to the Best Execution Interpretation, the NASD determined that Article III, Section 21 of the NASD Rules of Fair Practice (pertaining to the maintenance of books and records) should be amended. The proposed amendment to Section 21 would require that a member demonstrate its compliance with the Interpretation by noting on its order ticket the identities of the dealers contacted and the quotations received to determine the best inter-dealer markets as required by the amended Best Execution Interpretation.

* * * *

The Board believes that the proposed amendment to Article III, Section 21 of the NASD Rules of Fair Practice is necessary and appropriate to demonstrate compliance with the amendment to the Best Execution Interpretation and to better surveil the execution of trades in the non-NASDAQ, equity securities market. The Board thus recommends that members vote their approval.

Please mark the attached ballot according to your convictions and return it in the enclosed, stamped envelope to the "Corporation Trust Company." Ballots must be postmarked no later than July 1, 1988.

Questions concerning this notice can be directed to Eneida Rosa, NASD Office of General Counsel, at (202) 728-8284.

Sincerely,

Frank J. Wilson
Executive Vice President and General Counsel

Attachment

PROPOSED AMENDMENT TO ARTICLE m, SECTION 21 OF THE NASD RULES OF FAIR PRACTICE*

Books and Records

Section 21

(b) Marking of Customer Order Tickets

(i) A person associated with a member shall indicate on the memorandum for the sale of any security whether the order is "long" or "short," except that this requirement shall not apply to transactions in corporate debt securities. An order may be marked "long" if (l) the customer's account is long the security involved or (2) the customer agrees to deliver the security as soon as possible without undue inconvenience or expense.

(ii) A person associated with a member shall indicate on the memorandum for each transaction in a non-NASDAQ security, as that term is defined in Schedule H to the NASD By-Laws, the name of each dealer contacted and the quotations received to determine the best inter-dealer market.

^1/ See File No. SR-NASD-87-55, Securities Exchange Act Release 34-25637.

^2/ The NASD may implement the proposed price and volume reporting requirements in phases. A separate NASD notice to members discussing the requirements and operation of the new reporting system will be issued in the near future.

*New language is underlined.