OATS PHASE III -Differences between Reporting Member Exclusion and Exemptive Relief from the OATS Reporting Requirements
January 18, 2006
NASD is issuing this OATS report to clarify for members the difference between qualifying for exclusion from the definition of "Reporting Member" under NASD Rule 6951(n) and obtaining an exemption from the OATS Reporting Requirements pursuant to NASD Rule 6957.
On September 28, 2005, the Securities and Exchange Commission (SEC) approved amendments to Rules 6950 through 6957 (OATS Rules) relating to the Order Audit Trail System (OATS). These amendments contain, among other things, two provisions under which members may be relieved of certain OATS requirements. The first provision is an exclusion from the definition of OATS Reporting member that applies to firms whose specific business models would result in duplicative reporting because another member firm is reporting essentially the same information to NASD. This exclusion from the definition of Reporting Member relieves a firm from the full recording and reporting requirements of the OATS Rules. However, it does not relieve members from the clock synchronization requirements under Rule 6953. To determine if a member meets the definition of an OATS Reporting member, a firm must carefully review its business model to determine if it meets the criteria specified by NASD Rule 6951(n). If so, the member must enter into a written agreement with the Reporting Member to which it directs its order flow to qualify for the exclusion (as specified in more detailed below).
The second provision grants NASD exemptive authority in certain limited situations to provide relief for small members that do not otherwise qualify for exclusion from the definition of an OATS Reporting Member under NASD Rule 6951(n). This exemptive authority is limited to firms meeting specific criteria in situations where complying with the full scope of the rules would be unduly burdensome. The exemptive relief applies only to manual orders and then only to the transmission requirements of the OATS Rules. Firms that apply for and are granted exemptive relief must still record and maintain OATS information required under NASD Rule 6954. If a member that meets the definition of an OATS Reporting Member wishes to apply for exemptive relief pursuant to NASD Rule 6957, such member must complete and submit a formal request to NASD Market Regulation, as explained in more detail below.
Member firms should note that these two provisions are separate and distinct. A member firm that is not covered by the definition of an OATS Reporting Member, need not also apply for exemptive relief pursuant to NASD Rule 6957. The only requests for exemptions that will be considered are those filed by members who are covered by the definition of OATS Reporting Member.
Outlined below are the detail requirements for each of these two provisions.
Reporting Member Exclusion
The Phase III amendments to the OATS Rules exclude from the definition of Reporting Member firms that meet all four of the following criteria:
- The member must engage in a non-discretionary order routing process where the firm immediately routes all of its orders to a single receiving Reporting Member
- The member can not direct or maintain control over subsequent routing or execution by the receiving Reporting Member
- The receiving Reporting Member must record and report all information under NASD Rules 6954 (recording of order information) and 6955 (reporting of order information).
- The member must have a written agreement with the receiving Reporting Member specifying the respective functions and responsibilities of each party.
The Member Firm must engage in a non-discretionary order routing process where it immediately routes all of its orders to a single receiving Reporting Member.
If any delay results in the routing of an order due to system problems or other reasons, the member with which the order originated would be required to report OATS data.
One hundred percent of the firm's orders in NASDAQ securities must be routed to the same receiving Reporting Member. If the member accepts and routes an order to another venue, or executes an order internally, that member would be required to report OATS data for all of its orders, including those sent to the receiving Reporting Member on a non-discretionary basis.
If a member conducts proprietary business and executes a proprietary trade away from the receiving Reporting Member, then that member would be required to report OATS data for all of its orders, including those sent to the receiving reporting member on a non-discretionary basis. In other words, this is an "all or none" exclusion.
The Member Firm does not direct or maintain control over subsequent routing or execution by the Receiving Member.
All orders must be entered by the member on a non-discretionary basis into the receiving Reporting Member's system.
If the receiving Reporting Member's system provides the ability for the member to direct an order to a venue other than the receiving Reporting Member for execution and the member directs just one order away from the receiving Reporting Member, the member would be required to report OATS data for all of the orders entered into the receiving Reporting Member's system.
If the member relies on the receiving Reporting Member, or a system provided by the receiving Reporting Member, to determine where the order is routed for execution, the member will not be viewed as having direct control over subsequent routing or execution by the receiving Reporting Member.
The receiving Reporting Member must record and report all information under the OATS Rules.
The receiving Reporting Member will be required to identify the sending member in each New Order Report, Combined Order/Route or Combined Order/ Execution Report and include a Member Type Code of ("E") indicating the sending member qualifies for exclusion from the definition of OATS Reporting Member under NASD Rule 6951(n).
The Member Firm must have a written agreement with the receiving Reporting Member specifying the respective functions and responsibilities of each party to effect full compliance with the requirements of the OATS Rules.
Each party to the agreement must maintain all written documents. NASD will be monitoring firms' use of this exclusion closely and may periodically request a copy of any reporting agreements as part of its routine OATS surveillance activities.
Firms that meet the requirements of the Reporting Member Exclusion do not need to complete an OATS Exemption Request form.
Exemptive Relief from the OATS Reporting Requirements
Prior to these amendments, NASD did not have authority to grant any exemptions to the OATS Rules. These amendments give NASD the authority to grant exemptive relief from the OATS reporting requirements for manual orders to members that meet the following specified criteria:
- The member, current control affiliates and associated persons have not had a finalized disciplinary action within the last five years and within 10 years for fraud
- The member has annual revenue of less than $2 million
- The member conducts no market making activities
- The member does not execute principal transactions with its customers
- The member does not conduct any clearing or carrying activities for other firms
- The member must include a detailed explanation as to why complying with the OATS requirements would be a burden to the firm.
It is important to note that a member that has been granted exemptive relief is not exempt from any requirements as they relate to electronic orders. Further, for manual orders to which the exemption applies, the member must record OATS data as required by NASD Rule 6954 and retain the order data electronically for three years. In addition, the clock synchronization requirements continue to apply.
Additional information regarding Exemptions include:
- Exemption requests must be submitted in writing to the NASD Market Regulation Department no later than February 1, 2006 to ensure a determination by NASD staff by the May 8 implementation date.
- Copies of all exemption requests must be submitted to NASD's Office of General Counsel.
- Exemptions shall not exceed a period of two years. Members may request a subsequent exemption at or prior to the expiration of the initial exemption.
- NASD anticipates that exemptions may be granted for periods of less than two years depending on the facts and circumstances of each individual firm.
If you have any additional questions, please call the OATS Helpdesk at (800) 321-NASD.