Interpretive Letter to Joseph McLaughlin, Brown & Wood
April 9, 1998
Mr. Joseph McLaughlin
Brown & Wood
One World Trade Center
New York, NY 10048-0557
Re: Notice to Members 97-88
Dear Mr. Laughlin:
We are in receipt of your letter dated March 9, 1998 to Elisse B. Walter, Executive Vice President, Legal and Regulatory Policy, NASD Regulation, Inc., which was referred to our office for a response. In your letter, you request a correction to previously published Notice to Members 97-88 (NTM or Notice) as it applies to the application of NASD Rule 2320(g) (Three Quote Rule or Rule) to foreign securities executed on a foreign exchange. Specifically in your letter, you set forth a statement that subsequent modifications to the trade reporting requirements of Schedule H of the By-Laws should, by implication, also hold true for the requirements of the Three Quote Rule. Based on our review of the materials in question, we do not reach the same conclusion.
In your letter you state that, since the requirements to Schedule H were modified, in part, in 1990 through Notice to Members 90-58 to eliminate the requirement to report principal trades in foreign securities executed on a foreign exchange, the same modification should be read into the requirements that apply to the Three Quote Rule. NTM 90-58 fails, however, to specifically mention that such modifications applied to the Rule, and no rule filing was made with the Securities and Exchange Commission (SEC) which either amended Schedule H or the Rule.
You suggest that, because the requirements of the Three Quote Rule and Schedule H were proposed and approved in the same respective SEC releases in 1988,1 they were intended to apply to the same type of transactions or orders in non-Nasdaq securities. In this regard, you note that the Three Quote Rule cites to the definition of non-Nasdaq securities as it appeared in Schedule H at the time.2
In providing some clarity to this question, it is important to look to the language of NTM 90-58 as published in September, 1990. The Notice was published to clarify the requirements of Schedule H to assist members in complying with the Schedule.3 The principal clarification provided to members in the Notice was to provide guidance as to when a member needed to report transactions in foreign securities under Schedule H.4 The Notice concluded that all transactions in foreign securities executed in the U.S. are reportable under the Schedule. As to transactions in foreign securities that are executed outside the U.S., the Notice stated that if the transaction was reportable and reported to a foreign regulatory securities authority, or executed and reported to a foreign securities exchange, the transaction is not subject to Schedule H reporting obligations (emphasis added).
This clarification was intended to accommodate members in their reporting responsibilities and to prevent additional or duplicate reporting in transactions in foreign securities. In contrast, the Three Quote Rule is intended to assure that members conduct appropriate due diligence to ascertain that best execution obligation are satisfied. Because we realize that the application of the Rule in particular context could potentially interfere with, rather than promote, best execution, the Rule was recently amended to provide exemptive authority.
I hope that this is responsive to your letter. If you have any questions, please call me at (202) 728-8014.
David A. Spotts, Office of General Counsel, NASD Regulation
1 SEC Releases No. 34-25399 (February 26, 1988) and 34-25637 (May 2, 1988).
2 Prior to the NASD’s Manual revision project, the Three Quote Rule stated that it applied to transactions in "non-Nasdaq securities as defined in Schedule H to the By-Laws". In Schedule H, the term "non-Nasdaq securities" is defined as: "any equity security that is neither included in the National Association of Securities Dealers Automated Quotation System (Nasdaq) nor traded on any national securities exchange".
3 Schedule H, which became fully effective August 1, 1989, requires the reporting of price and volume information for principal transactions in non-Nasdaq securities whenever a member exceeds the minimum daily thresholds of 50,000 shares or $10,000, on either side, in a given non-Nasdaq security.
4 In the Notice, the NASD specifically stated that "the term ‘non-Nasdaq security’ includes all foreign equity securities, ADRs, or shares traded in the U.S. other than on Nasdaq or on a national securities exchange." In addition, the Notice stated that "foreign exchanges are not national securities exchanges" as the term is used in the Schedule H definition, and concluded that "the fact that a foreign security is also traded on a foreign exchange does not, per se, exclude all transactions in that security from the Schedule’s coverage."