SEC Approval of Trade Reporting for Regular Nasdaq Securities

EXECUTIVE SUMMARY

On March 10, the Securities and Exchange Commission (SEC) approved amendments to Schedule D regarding trade reporting for regular Nasdaq^® equity securities. The trade reporting requirements are similar to those currently in place for Nasdaq National Market System (Nasdaq/NMS^®) securities. Trade reporting of all Nasdaq equity issues will enhance the information available to the public and provide investors with instant, up-to-the-minute information on the securities traded in The Nasdaq Stock Market.^SM Trade reporting will also greatly improve the NASD's ability to detect or deter manipulative or abusive trading practices.

Beginning June 15, members will be required to report both broker-to-broker and internalized transactions in regular Nasdaq securities to the Automated Confirmation Transaction (ACT)^SM service within 90 seconds after execution. Quotations and trade reports in regular Nasdaq securities will be identified by the system with an "s" market center indicator: quotes and last-sale reports of Nasdaq/NMS issues will be identified with a "q" indicator. All Nasdaq securities will be exempt from the SEC's new "penny stock" rules, but transaction reporting for regular Nasdaq securities will not make these issues eligible automatically for margin treatment or for state "blue sky" exemptions. Finally, the new transaction reporting requirements will not apply to transactions in convertible debt securities.

The amendments will be effective on June 15 when end-of-day volume reports for regular Nasdaq equity securities will no longer be necessary. The text of the amendments follows the discussion below.

BACKGROUND AND DESCRIPTION OF AMENDMENTS

The SEC's approval of transaction reporting for regular Nasdaq securities represents a significant evolutionary step that will materially enhance the visibility and integrity of The Nasdaq Stock Market. Transaction reporting increases transparency of information for investors and issuers, facilitates best execution, permits immediate collection and scrutiny of trading information for regulatory purposes, and permits the compilation of historical price and volume data for analysis and research. Moreover, the introduction of trade reporting places regular Nasdaq securities on an equal footing with Nasdaq/NMS and exchange-listed securities in terms of real-time information available to broker/dealers and their customers. The NASD has nine years of experience with real-time reporting of Nasdaq/NMS securities and believes that the increased visibility associated with trade reporting will expand the universe of institutional and public investors interested in purchasing these securities. This will provide increased liquidity in the marketplace for the benefit of all investors.

Real-time transaction reporting and the related regulatory benefits will also permit the exemption of regular Nasdaq securities from the application of the SEC's "Penny Stock Disclosure Rules," some of which will take effect on July 15. Generally, the SEC rules define any stock selling for less than $5 per share as a penny stock and subject those securities to additional regulatory requirements. Exempted from the rules, however, are those lower priced stocks that remain fully qualified for inclusion in the Nasdaq market. The SEC has granted this exemption from the penny stock rules for securities listed on Nasdaq, based, in part, on the significantly enhanced transactional information that will be made available to investors through the trade-reporting function.

From a regulatory perspective, real-time reporting requirements will enhance significantly the automated market surveillance oversight performed by the NASD and provide more immediate and useful information for investigating questionable conduct, such as insider trading and manipulative activity. Presently, NASD Market Surveillance primarily uses end-of-day volume statistics as the source of information for trades in regular Nasdaq securities. Real-time trade reports significantly improve the NASD's ability to effectively monitor trading as it occurs. For example, as real-time trade reporting is fully implemented, the trading data will be available on the NASD's equity audit trail, which integrates last-sale, clearing, and inside quotation data for reported securities. In addition, transaction data will be added to daily quote and trade-comparison reports and to exception-based systems that monitor for marking-the-close violations, trading during trading halts, volume concentrations, late trade reporting, and other activity monitored by Market Surveillance. Collectively, these surveillance advances will reinforce the integrity and image of Nasdaq as a world-class securities market.

The amendments to Schedule D contain trade-reporting requirements that closely parallel those currently in place for Nasdaq/NMS securities. The new rules will require transactions in regular Nasdaq securities to be reported to the NASD within 90 seconds after execution. Members are currently reporting broker-to-broker transactions in regular Nasdaq securities into the ACT service for comparison processing and are reporting total volume of purchases and sales in Nasdaq securities at the end of the day. The new requirements reduce the current time frames for entering transactions into ACT from 15 minutes to 90 seconds and expand the securities eligible for reporting through ACT to include all internalized transactions. Given the implementation of trade-by-trade reporting, the existing requirement for end-of-day volume reporting of regular Nasdaq securities will be eliminated. Members should note, however, that transactions in convertible debt securities will remain subject to end-of-day volume reporting requirements, similar to those currently in place for all regular Nasdaq securities.

The new rules specify which party to a transaction is required to report (in most transactions, the market maker registered in the Nasdaq security is the reporting party). They also provide reporting requirements, such as reporting transactions at the selling or purchasing price, irrespective of markups, markdowns, or commissions. The trade-reporting rules state that aggregating trade reports is allowable under certain circumstances and sets forth permissible aggregation practices. Members should note that for ACT comparison purposes, however, members may need to indicate separate trades with separate contra-parties. These requirements also parallel those currently in place for Nasdaq/NMS securities.

For members that account for five or fewer trades per day, the NASD will provide an alternative means to effectuate trade reports through the ACT service desk. The NASD operates the ACT service desk to facilitate members that account for fewer than five trades a day on average and that do not have Nasdaq Workstation^® equipment. For more information on the ACT service desk, contact ACT Operations at (212) 858-4342.

Last-sale information for regular Nasdaq equity securities will be disseminated to the marketplace through information vendors on a real-time basis throughout the trading day. With the advent of trade reporting in regular Nasdaq and the corresponding increase in information that will be provided to members and investors, the NASD will revise the fee schedule for receipt of last-sale information for both Nasdaq/NMS and regular Nasdaq securities. The current service charge of $7.50 will be increased to $9. The modest increase will recover the costs of collecting, processing, and disseminating the additional information.

Vendors will receive the additional data over high-speed lines. A market center identifier, attached to both last-sale data and to quotations, will differentiate regular Nasdaq securities from Nasdaq/NMS securities. Regular Nasdaq quotes and transaction reports will carry an "s" identifier; Nasdaq/NMS quotes and last-sale data will be displayed with the "q" identifier. This information will be generated by the Nasdaq processor and does not require data entry by reporting parties.

Members should note that Nasdaq/NMS equity securities will continue to receive separate regulatory treatment in areas such as margin accounts and state securities commissions' merit review requirements. Transaction reporting in regular Nasdaq issues does not render these stocks automatically eligible for sales to margin account customers nor for exemptions from state "blue sky" regulations. Members should alert their associated persons to maintain the regulatory distinctions between regular Nasdaq and Nasdaq/NMS securities, especially as they pertain to margin and blue-sky treatment.

The new trade-reporting rules become effective June 15. Questions regarding this Notice may be directed to Bernard Thompson, Assistant Director, Market Surveillance, at (301) 590-6436 or to Beth E. Weimer, Associate General Counsel, at (202) 728-6998.

TEXT OF NEW RULES

The rule change adds a new Part XIII to Schedule D to the NASD By-Laws and amends the ACT Rules. (Note: Additions are in italics; deletions are in brackets.)

PART XIII

REPORTING TRANSACTIONS IN NASDAQ SECURITIES

This Part has been adopted pursuant to Article VII of the Corporation's By-Laws and sets forth the applicable reporting requirements for transactions in Nasdaq securities (excluding convertible bonds that are quoted through the Nasdaq system) ("designated securities") that are not classified as Nasdaq National Market System securities. Members shall utilize the Automated Confirmation Transaction Service ("ACT") for transaction reporting.

Section 1 — Definitions

Section 2 — Transaction Reporting

• • • Interpretation of the Board of Governors

The Association seeks to emphasize the obligations of members to report transactions in designated securities within 90 seconds after execution. All transactions in designated securities not reported within 90 seconds after execution shall be reported as late, and the Association routinely monitors members' compliance with the 90 second requirement. If the Association finds a pattern or practice of unexcused late reporting, that is, repeated reports of executions in designated securities after 90 seconds without reasonable justification or exceptional circumstances, the member may be found to be in violation of Article 111, Section 1 of the Association's Rules of Fair Practice. Exceptional circumstances will be determined on a case by case basis and may include conditions such as extreme volatility in a designated security, or in the market as a whole. Timely reporting of all transactions in designated [eligible] securities is necessary and appropriate for the fair and orderly operation of the Association's marketplace, and the Association will view noncompliance as a rule violation.

Part XIII renumbered as Part XIV

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RULES OF PRACTICE AND PROCEDURES FOR THE AUTOMATED CONFIRMATION TRANSACTION SERVICE

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¹For examples of reporting procedures, refer to Part XII of this Schedule, "Reporting Transactions in Nasdaq National Market System Securities."