SEC Approval of Risk Management Functions of the Automated Confirmation Transaction Service

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EXECUTIVE SUMMARY

On October 26, 1990, the Securities and Exchange Commission (SEC) approved the risk management functions of the Automated Confirmation Transaction (ACT) service. ACT risk management began operating Monday, October 29, and allows clearing firms to set daily purchase and sale trading thresholds for their correspondent executing broker-dealers, establishes a "super cap" calculation and "blockbuster" trade value, and allows clearing firms to monitor more closely the activities of their correspondents. The NASD also filed service charges for the risk management service with the SEC; those fees became effective November 1, 1990. Starting the week of November 26, 1990, the ACT service also began comparing trades in listed or Consolidated Quotation Service (COS) stocks.

BACKGROUND

For the past few months, self-clearing firms have been participating in the NASD Automated Confirmation Transaction (ACT) service. The ACT service provides for on-line comparison of telephone-negotiated trades within minutes of executing the trade. In addition, ACT reports eligible trades to the tape and, at the end of the trading day, sends all locked-in trades to the National Securities Clearing Corporation (NSCC).

In order to establish ACT as the industry standard for reporting and comparing equity transactions in The Nasdaq Stock Market, the SEC has mandated that all broker-dealers participate in the service.

ACT same-day comparison provides many benefits to all parties concerned — clearing firms and their correspondents (introducing brokers), market makers, and order-entry firms.

Among the features ACT provides are same-day comparison for matching of purchases and sales; on-line browsing of open and locked-in trades; ability to clean up open trades directly from a browse screen; off-line, end-of-day aggregate match processes; T+l "as of" trade entry; and clearing-firm risk management capabilities. The NASD also offers access to the ACT Service Desk for firms executing an average of five or fewer trades per day.

Finally, on November 26, 1990, over-the-counter transactions in listed stocks began being compared through ACT.

HOW ACT OPERATES

After completing a trade in a Nasdaq/NMS, other Nasdaq, or listed CQS security, each participant reports trades to the ACT system through a Nasdaq Workstation^SM terminal or Computer-to-Computer Interface (CTCI). The custom-designed ACT menu leads the Workstation user through entry (via a short form entry in the dynamic quote partition or a longer entry format in a separate ACT partition) as the trade report is entered as either a market maker or an order-entry firm. These entries are explained in detail in the ACT User Guide.

Reported trades are subject to continuous attempts to match with the other side. When two sides match, they are locked in and sent at the end of the day to NSCC, where contract sheets are produced.

All market makers are required to submit Nasdaq/NMS and listed trades within 90 seconds, and all other Nasdaq trades within 15 minutes after execution of the trade.

Order-entry firms must respond within 20 minutes of execution either by entering their version of the trade or by using the "Accept" or "Decline" functions available on the ACT browse screen.

Open trades may be canceled by using the browse screen or by CTCI entry, and Iocked-in trades may be broken using the browse screen. However, in order to break a locked-in trade, "break" entries must be submitted by both the buyer and seller.

At the end of the trading day, all locked-in trades are sent to the NSCC, and all open trades become eligible for the end-of-day aggregate match. Trades with the same parties, security identifier, and price, but with different volumes are combined, matched, and sent to the NSCC. At times, this aggregate process may result in one or more locked-in trades being sent to clearing and another open trade with the unmatched volume remaining in the ACT system. This open trade then becomes available for reconciliation through ACT on T+l.

The ACT 2 (T+l) cycle allows a final cleanup of all open trades remaining from trade day. Firms may use the ACT 2 browse function to enter "as of" entries in order to effect a match, or they may "Accept," "Decline," or "Cancel" trades from the previous day. Entry of ACT 2 "as of" trades can be accomplished until 1 p.m., and ACT browse up-dates until 2:30 p.m. on T+l.

At the end of the ACT 2 cycle, a second aggregate match is attempted on the remaining open trades. When this is completed, all remaining open trades that were entered into the ACT system on trade date are automatically locked in and sent, as such, to NSCC. All open "as of" trades, however, are deleted from the ACT file.

ACT RISK MANAGEMENT

Since ACT accelerates the comparison cycle and creates locked-in trades, clearing firms gain extensive risk management capabilities to monitor the activities of their correspondents.

Using ACT Risk Management, clearing firms can choose to monitor purchase and sale activity, establish dollar thresholds for the trading day, examine large trades, establish and delete clearing relationships, and develop an internal data base through a real-time data feed of correspondent activity.

Thresholds

ACT calculates separate purchase and sale dollar totals for each executing broker. These running totals are compared against a purchase and sale threshold established by the clearing firm for each of its correspondents. When executing brokers' totals reach 70 percent of the assigned threshold, an alert message is transmitted to the clearing and executing firms. A second message is sent if an executing broker exceeds its threshold. The clearing firm can reset thresholds any time during the trading day and has the option of setting unlimited thresholds.

Super Cap Limits

As an additional feature, the ACT Risk Management process calculates the totals of compared locked-in trades for each correspondent. This figure will be related to a "Super Cap" total, which is twice the assigned threshold but never less than $1 million.

If a correspondent broker's locked-in trades exceed the Super Cap amount, the ACT system will place a designated mark next to all of its quotes (if the firm is a market maker), and will cause all trades greater than $200,000 to be held for 15 minutes for clearing-firm approval. Trades not approved in this 15-minute time period will be rejected and sent back to the contra party.

Once the Super Cap is penetrated, it is the responsibility of the clearing firm to either raise the threshold, thus resetting the Super Cap for that correspondent, or to delete the clearing arrangement, thereby ceasing to act for that correspondent.

Blockbuster Trades

As an additional feature, all trades of $1 million or more so-called "blockbuster trades" will be subject to clearing-firm approval. The trade report will be held for a 15-minute time frame in order to allow the clearing broker an opportunity to examine the trade details. If during the 15-minute "held" period the clearing firm does not actively reject the trade, it will be processed and matched like any other ACT trade report. Clearing firms, however, have the option of bypassing blockbuster trade processing for designated correspondents.

ACT Risk Management Features for Clearing Firms

All correspondent trade activity may be monitored from a special Clearing Firm Browse screen designed specifically to allow these firms the ability to "see" locked-in and open trade reports entered into the ACT system. A separate display permits the clearing firm to monitor and update correspondent threshold limits and also provides the means to cancel a specific clearing relationship.

An additional feature is available to clearing firms with a CTCI interface. These firms are able to receive a real-time data feed of all trade detail and comparison activity of its correspondents. This will allow the clearing firm to create an internal data base if the clearing firm is interested in developing more intensive risk management procedures for its correspondents.

ACT FEE STRUCTURE

The following fee structure applies to the ACT service:

• Compared Trades — $.0125 per 100 shares (minimum 400 shares or $.05 and maximum 7,500 shares or $.9375).
• Query Charge — $.25 per query. The first accept or decline processed is free, and a query is defined as entering a new parameter (i.e., stock symbol or market-maker identifier).
• Late Fees will not be charged.
• ACT 2 Input Fees — $.25 per trade, in addition to comparison charge.
• ACT Only Terminal Fees — $50 per month. (Defined as a terminal set-up for ACT only usage; that is, it is not being charged for any other Nasdaq service, such as Level 2/3 or Trade Acceptance and Reconciliation Service.
• CTCI Fee — $500 per month per line.
• Service Desk — $50 per month.
• Clearing-Firm Risk Management — $.02 per side and $15 per month per correspondent.