Interpretive Letter to Jack Hodges, William O'Neil + Co, Inc.

Mr. Jack Hodges
AVP Trading
William O’Neil + Co, Inc.
12655 Beatrice Street
Los Angeles, CA 90066-7002

Dear Mr. Hodges:

This letter is in response to your letter dated June 12,1998, in which you inquired about the Order Audit Trail System (OATS). It is also to formalize our previous telephone conversation in which we discussed our responses. As you will note and as we discussed, we do not have answers to all of your questions. We ask your patience as we continue to formulate a complete response.

By way of background, your letter states that William O’Neil + Co., Inc. ("O’Neil") is an institutional brokerage firm that trades OTC stocks for its customers and for its own account. O’Neil does not make markets. Orders for customers are either routed to market makers or they are worked on Instinet (an ECN). Based on the foregoing, you raise several questions.

The first question asks how O’Neil should report to OATS the execution of an order or orders placed with Instinet, if the orders result in partial executions. For example, a customer order for 5000 shares comes back as executions of 200, 500, 300, 700, 100, etc.

An order received from a customer and placed with Instinet would require O’Neil to submit a New Order Report and a Route Report to OATS. Instinet would submit a New Order Report and an Execution Report or multiple Execution Reports to OATS. O’Neil would not be responsible for making Execution Reports to OATS. Examples of this scenario can be found in the June 30,1998 version of the OATS Reporting Technical Specifications ("Tech Spec") in Section 4, at 4.3.7: Order Execution via an ECN.

In the follow-on situation, you raise the question of working multiple customer orders in the same stock. This requires the firm to go back and allocate shares at different price levels from all the executions to the various accounts.

Again, as we noted above, O’Neil would report each order initiated on behalf of a customer or the firm as a New Order Report, which then would be followed by a Route Report to a market maker or an ECN. When O’Neil bunches orders before routing them to a market maker or ECN, O’Neil would file individual New Order Reports and an individual Route Report for each order. However, each Route Report would have the Bunched Indicator of "Y" with the Routed Share Quantity equal to the total number of shares being bunched. An example of this can be found in the Tech Spec at scenario 4.3.15: Bunched Routing. Finally, the market maker or ECN would then be responsible for a New Order report for each order it receives and an Execution Report for each order fully or partially executed. Again, O’Neil would not be responsible for making Execution Reports to OATS.

Your second question inquires about your firm’s OATS reporting obligations when modifying orders sent to an ECN, such as Instinet. You note that orders routed to Instinet must have limit prices even if they are market orders. In addition, your trader will modify the limit price as the market conditions warrant. You note that in a fast moving market this can mean modifying the limit price 10 or more times a minute. Finally, you mention a feature called "pegging" on Instinet that allows your trader to peg the price of the order to, for example, the middle of the quoted market in a stock. Again you note that in a fast moving market that could mean that the "pegged" price of the order on Instinet could change 20 times in a minute.

The first part of this question is still under review and as such we are deferring our response until a later date. In answer to the second part of the question, the "pegged" order scenario you gave, the firm would be required to file a New Order Report and a Route Report for the order with a Special Handling Code of "PEG", in addition to the other required elements. As long as the trader did not make any modifications to this order, Instinet would track the changes based on the instructions given.

Your third and final question asks about your OATS reporting requirements where your firm is negotiating an order or part of an order. You note that you may enter a bid at a price higher than your existing bid on Instinet, followed by further counter offers or bids. You further indicate that this process may result in an execution, but it may be only for a portion of the order. The process would then begin again for the remainder of the order. You state that recording all of these bids and counters would be very difficult if not impossible.

Your firm is required to file a New Order Report and a Routing Report when an order is sent to Instinet, but is not required to report the negotiations between the routing and an execution. For example, suppose your firm placed an order on Instinet for 1,000 shares at 10 and then proceeded to negotiate with one or more firms. As a result of the negotiations, 500 shares at 10 1/8 were executed in a transaction. Only the New Order Report and the original Route Report of 1000 at 10 routed to Instinet would be reported by your firm. Instinet would file the Execution Report for the 500 shares at 10 1/8. None of the negotiations between your original Route Report and the Instinet Execution Report would be transmitted to OATS.

We hope that this letter has been responsive to your inquiry to the extent noted. Please understand that the opinions expressed in this letter are staff opinions only and have not been reviewed or endorsed by the Board of Directors of NASDR. The letter responds only to the issues you have raised based on the facts as you have described them in your letter and does not necessarily address any other rule or interpretation of the NASD or all the possible regulatory and legal issues involved.

We are reviewing your unanswered question and hope to respond to it in the near future. Should you have any further questions please contact me at (301) 590-6530.

Sincerely,

Kevin P. McEvoy
Regulatory Specialist
Market Regulation Department